Calicut University 6th sem Bcom Financial Derivative chapter 3 part 1 Forwards and Futures

Understanding Forward Prices and Futures Trading

What is a Spot Price?

• The current price at which an asset or commodity is available in the market is referred to as the spot price.

• It represents the simplest and oldest form of derivatives trading, known as forward contracts.

Overview of Forward Contracts

• A forward contract is an agreement between two parties to buy or sell an asset at a predetermined future date for a price agreed upon today.

• One party acts as the long buyer while the other acts as the seller, facilitating risk transfer between them.

• These contracts can be utilized for both hedging against risks and for speculative purposes.

Key Features of Futures Trading

• The transition cost associated with trading futures is generally lower compared to other forms of trading.

• An important aspect of futures trading involves understanding tick size, which refers to the minimum change allowed in price quotations.

Daily Settlement Mechanism

• Futures contracts are marked-to-market on a daily basis, meaning that positions are settled each day based on current market prices.

• This daily settlement ensures that both parties fulfill their obligations under the contract, maintaining market integrity and reducing default risk.