Chapter 14

Chapter 14 - 14-1Learning ObjectivesYou will derive many...

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Unformatted text preview: 14-1Learning ObjectivesYou will derive many future benefits if you have a good understanding of:1. The basics of futures markets and how to obtain price quotes for futures contracts.2. The risks involved in futures market speculation.3. How cash prices and futures prices are linked.4. How futures contracts can be used to transfer price risk.14-214-2Futures ContractsOur goal in this chapter is to discuss the basics of futures contracts and how their prices are quoted in the financial press. We will also look at how futures contracts are used, and the relationship between current cash prices and futures prices.14-314-3Forward Contract Basics, I.A forward contract is an agreement made todaybetween a buyer and a seller who are obligatedto complete a transaction at a set date in the future. The buyer and the seller know each other, and they negotiate the terms of the contract.The term of a forward contract are customized.What to trade; Where to trade; When to trade; How much to trade; What quality of good to tradeall customized under the terms of the forward contract.14-414-4Forward Contract Basics, II.Important: The price at which the trade will occur is also determined when the agreement is made. This price is known as the forward price.Generally, no cash changes hands until the trade is made.One party faces default risk, because the other party might have an incentive to default on the contract.To cancel the contract, both parties must agree. One side might have to make a dollar payment to the other to get the other side to agree to cancel the contract.14-514-5Futures Contract Basics, I.A Futures contract is an agreement made todaybetween a buyer and a seller who are obligatedto complete a transaction at a set date in the future.The buyer and the seller do notknow each other.The "negotiation" occurs in the fast-paced frenzy of a futures pit.The terms of a futures contract are standardized.What to trade; Where to trade; When to trade; How much to trade; what quality of good to tradeall standardized under the terms of the futures contract.14-614-6Futures Contract Basics, II.The price at which the trade will occur is determined "in the pit or, increasingly, in the electronic market.This price is known as the futures price.No one faces default risk, even if the other party has an incentive to default on the contract.The Futures Exchange where the contract is traded guarantees each tradeno default is possible.To cancel the contract, an offsetting trade is made, either in the pit or in the electronic market. The trader of a futures contract may experience a gain or a loss.14-714-7Organized Futures ExchangesEstablished in 1848, the Chicago Board of Trade (CBOT) was the first organized futures exchange in the United States....
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Chapter 14 - 14-1Learning ObjectivesYou will derive many...

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