A Note on Currency and Index Futures

Abstract

The note provides some of the basic definitions used in futures contracts. It covers in detail the application of futures as a derivative instrument, and how market participants like hedgers, speculators and arbitrageurs use futures. The note also explains the role of the clearing house and settlement procedures in futures contracts, and why the contracts need to be marked to market. The objective of this note is to make the reader understand better, the use of futures as a tool for the purpose of hedging, speculating and arbitraging particularly, in terms of currency and index futures. The note is intended to provide supporting material for case studies/courseware pertaining to currency and index futures.

Futures trading started way back in 1865 on the Chicago Board of Trade (CBOT), but prior to 1972, the underlying asset of futures contracts were agricultural commodities.

A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. The underlying asset of a futures contract may be an agricultural commodity (such as corn, wheat, soybean, or soybean oils), or a financial instrument (such as treasury bonds, treasury notes and shares). Unlike forward contracts , futures contracts are standardized (in terms of contract size, expiration month, trading cycle, etc.) and are traded in an organized exchange.

In referring to futures contracts, there are number of other terms that are commonly used. Spot price is the price at which an asset trades in the spot market . The price at which the futures contract trades in the futures market is called the futures price (Refer Exhibit II). A contract cycle is the period over which a contract trades. An investor can take two positions in a futures contract, a 'long futures position' or a 'short futures position.' The investor is said to have taken a long position when he/she is buying, and is said to have taken a short position when he/she is selling, a futures contract. Expiry date is the last day on which the contract is traded at the end of which it will cease to exist. The amount of the asset that has to be delivered under a contract is known as the contract size. The difference between two futures prices is known as spread. The difference between two futures prices for the same underlying commodity on two different expiration dates is known as 'intra commodity' spread. The difference between two futures prices for two different but related commodities is known as 'inter commodity' spread. The price difference between the two markets for the same commodity is known as 'inter market' spread........

        Case Code   MISC013
   Case Length    18 Pages
              Period   
 Organization    
        Pub Date     2004
Teaching Note    Not Available
     Countries    
      Industry   

Issues

Definitions, futures contracts, application, futures, derivative instrument, market participants, hedgers, speculators, arbitrageurs, futures, clearing house, settlement procedures, futures contracts, currency, index , futures.