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Futures Contract

Futures Contract – Financial institutions use Hedging to increase financial stability and reduce the risk of financial distress.

What is Futures Contract?

Forward Contract and Future Contract forms are considered the two most essential products for Hedging. They are also called linear derivatives as they follow a zero-sum game, i.e. profit of party A is the loss of party B.

As opposed to a forward contract, a futures contract is more formal with the involvement of an exchange. The contract is a legally binding agreement to buy or sell the underlying assets in a predesignated month in the future at a price agreed upon today by the buyer/seller. Futures are more used for commodity hedging.

Futures contracts are standardised with predefined quality, quantity, delivery time, and location for each specific commodity.

Example of Forward Contract:

Future contracts are often used in the commodity market. Let’s take an example of a cereal producer. The cereal producer takes a long position in corn, and party B is corn farmers taking a short position in corn. One party takes a long position, agreeing to purchase the corn at a future date for a specified price, while the other party is short, agreeing to sell the corn on that same date for that same price.

Why is a Future Contract important?

Future contracts are considered one of the most widely used hedging products, especially in the commodity market. Hence, risk managers must understand the forward contract well.

Owais Siddiqui
1 min read
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