Page 44 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Unit 4: Future Contracts

4.1.2 Characteristics of Futures Contracts Notes

Following are the salient features of futures contracts:
1. Futures are highly standardised contracts that provide for performance of contracts through
either deferred delivery of asset or final cash settlement;

2. These contracts trade on organized futures exchanges with a clearing association that acts
as a middleman between the contracting parties;
3. Contract seller is called 'short' and purchaser 'long'. Both parties pay margin to the clearing
association. This is used as performance bond by contracting parties;
4. Margins paid are generally marked to market-price everyday;
5. Each futures contract has an associated month that represents the month of contract delivery
or final settlement. These contracts are identified with their delivery months like July-
Treasury bill, December $/DM etc.
6. Every futures contract represents a specific quantity. It is not negotiated by the parties to
the contract. One can buy or sell a number of futures contracts to match one's required
quantity. Because of this feature, 100% hedging is not possible. There may be over or
under-hedging to some extent.

Self Assessment

Fill in the blanks:

1. If you buy a ………… contract, you are basically agreeing to buy something that a seller
has not yet produced for a set price.
2. The future date is called the ………… date or final settlement date.

3. Futures contracts, unlike forwards, are traded on ………….
4. ………….. paid are generally marked to market-price everyday.
5. Contract seller is called ………and purchaser …………..

4.2 Types of Future Contracts

Futures contracts are of three major categories:
4.2.1 Stock Index Futures

These futures contract without actual delivery were introduced only in 1982 and are the most
recent major futures contract to emerge. In the United States, these contracts trade on several
market indices like Standard and Poor's 500, a major market index, the NYSE Index and the
Value Line Index. Numerous contracts on industry indices are now trading as well.
A stock index futures contract is a contract to buy or sell the face value of the underlying stock
index where the face value is defined as being the value of index multiplied by the specified
monetary amount.

This device makes it possible to equate the value of the stock index with that of a specific basket
of shares with the following specifications.
1. The total value of shares must match the monetary value of the index.

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