Exploring changes in futures prices - Financial Market Essay

Exploring changes in futures prices - Financial Market - Essay Example This report aims at solving issues and problems related to future price changes and how best they can be used to best suit the needs of the market. Future contracts A future is contract between two parties to buy or sell a financial asset or instrument at a fixed future date and at a predetermined price as argued by Chandra, (2008). Futures are traded in the exchange which acts as an intermediary between the two parties. The terms of future contracts are standardized as they indicate what is to trade, when to trade and where to trade. There are three types of protections built-in to ease credit risk in the futures. One, the daily settlement which is is usually settled in cash basis is a major protection that plays a significant role in easing credit risk. Two, margin which the balance is kept in the accounts to cover several days’ worth of potential market to market transfers. It is necessary for every trader to understand this aspect of margin in reference to credit risk. Fin ally, the clearing house which guarantees transactions by insures daily settlement on market gains and losses. Forward contacts are not investments as a result it costs nothing to enter into the legally binding agreement. There are three ways of settling or closing out a contract. First, enter in an offsetting transaction. Two, make or taking physical delivery of the underlying commodity. Finally, cash settlement is another aspect that should be elaborated to traders entering into any form of future contracts. Over the counter forward contracts are flexible but they have their own disadvantages. They are unregulated as no formal body regulates the players in the market and they are only designated for specific needs. History of future contracts The first standardized future to be listed in the exchange was the Chicago Board of Trade (CBOT) in the year 1848 in the United States. Other major exchanges in U.S include New York Mercantile Exchange (1872), Chicago Mercantile Exchange (187 4) and Kansas City Board of Trade (1882). In Europe futures contracts in the Exchange include London international financial futures Exchange (LIFFE) and Amsterdam, Paris, Belgium exchanges merged with LIFFE to create Euronext LIFFE. This also merged with the Lisbon Stock Exchange. Types of future contracts There are two types of futures, those that provide cash settlement and those that provide physical delivery for commodity. Commodity futures such as coffee require physical delivery on the agreed day. Stock index future contract is an example of a cash settlement contract. They are settled on cash on the basis of index number at the closing day. Treasury bond futures are settled through physical delivery of treasury bonds. Upon maturity, they have to convert into deliverable bond. A holder of short must deliver 100 treasury bonds must mature for at least 15 years. Treasury bill futures. Treasury bills matures after 3 months and that’s when the holder delivers its face valu e Currency futures. Most of the currencies are traded at banks on a cash basis. Usefulness of future contrac