Forwards and Futures
13 Pages Posted: 14 Jun 2009
This technical note introduces the basics of forward and futures contracts. It covers the very simplest contract on financial assets with no income and expands the discussion to cover contracts on financial assets with dividends, contracts on foreign currency and commodities. There is a discussion on the difference between forward/futures prices and the expected spot rate.
Oct. 3, 2008
ForwardS and Futures
Initially, we will assume that a forward and futures contract is the same thing. Both are contracts where a buyer agrees to buy and a seller agrees to sell at a set price on a future date. The key is that the price for exchange is set today and represents a fair price for both the seller and the buyer. An example of such a contract would be a situation where a farmer (sell) and a cereal producer (buy) agree to exchange 1,000 bushels of corn at $ 2.54/bushel six months from today. The farmer and the producer both lock in a fixed price for exchange in six months. Without this type of contract, neither the farmer nor the producer could lock in prices today for future delivery.
The result is that there is a set of prices in the market for commodities with different delivery dates. There is the cash (spot) price, which is the price for delivery today; on December 23, 2006, the cash price for a bushel of oats was $ 2.22. In addition, there is the price for delivery in 30 days or 90 days. All those prices would be different. For example, on December 23, 2006, the futures prices per bushel for oats on the Chicago Board of Trade were as shown in Figure 1:
Figure 1. Futures prices per bushel for oats.
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Keywords: Futures, Forwards, Derivatives
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