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    M.R.
    Forward contracts require physical delivery of an asset at a predetermined price on a future date. There is risk of default if the price changes significantly. Futures contracts are similar but involve daily price adjustments to limit default risk, cash settlement instead of physical delivery, and standardized trading on exchanges. Futures can be used for speculation by betting on price movements or hedging to protect against risks like changing commodity prices or interest rates. Hedging involves taking a long or short position in futures contracts to offset financial risks from price increases or declines. Swaps involve an agreement where two parties exchange payment obligations, usually related to interest rates or currencies.

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    Derivatives

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    M.R.
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    Forward contracts require physical delivery of an asset at a predetermined price on a future date. There is risk of default if the price changes significantly. Futures contracts are similar but involve daily price adjustments to limit default risk, cash settlement instead of physical delivery, and standardized trading on exchanges. Futures can be used for speculation by betting on price movements or hedging to protect against risks like changing commodity prices or interest rates. Hedging involves taking a long or short position in futures contracts to offset financial risks from price increases or declines. Swaps involve an agreement where two parties exchange payment obligations, usually related to interest rates or currencies.

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    Forward contracts require physical delivery of an asset at a predetermined price on a future date. There is risk of default if the price changes significantly. Futures contracts are similar but involve daily price adjustments to limit default risk, cash settlement instead of physical delivery, and standardized trading on exchanges. Futures can be used for speculation by betting on price movements or hedging to protect against risks like changing commodity prices or interest rates. Hedging involves taking a long or short position in futures contracts to offset financial risks from price increases or declines. Swaps involve an agreement where two parties exchange payment obligations, usually related to interest rates or currencies.

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    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    30 views2 pages

    Derivatives

    Uploaded by

    M.R.
    Forward contracts require physical delivery of an asset at a predetermined price on a future date. There is risk of default if the price changes significantly. Futures contracts are similar but involve daily price adjustments to limit default risk, cash settlement instead of physical delivery, and standardized trading on exchanges. Futures can be used for speculation by betting on price movements or hedging to protect against risks like changing commodity prices or interest rates. Hedging involves taking a long or short position in futures contracts to offset financial risks from price increases or declines. Swaps involve an agreement where two parties exchange payment obligations, usually related to interest rates or currencies.

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    of 2

    Forward Contract

    Forward contracts are agreements where one party agrees to buy a commodity at a specific price on a
    specific future date and the other party agrees to make the sale. Goods are actually delivered under
    forward contracts. Unless both parties are financially strong, there is a danger that one party will default
    on the contract, especially if the price of the commodity changes markedly after the agreement is
    reached.

    Future Contract
    A futures contract is similar to a forward contract but with three key differ- ences:
     Futures contracts are “marked to market” on a daily basis, meaning that gains and losses are
    noted and money must be put up to cover losses. This greatly reduces the risk of default that
    exists with forward contracts.
     With futures, physical delivery of the underlying asset is never taken—the two parties simply
    settle with cash for the difference between the contracted price and the actual price on the
    expiration date.
     Futures contracts are generally standard- ized instruments that are traded on exchanges,
    whereas forward contracts are

    Future/Hedging/Swap

    Futures are used for both speculation and hedging. Speculation involves betting on future price
    movements, and futures are used because of the leverage inherent in the contract. Hedging, on the
    other hand, is done by a firm or an individual to protect against a price change that would otherwise
    negatively affect profits. For example, rising interest rates and commodity (raw material) prices can hurt
    profits, as can adverse currency fluctuations. If two parties have mirror-image risks, they can enter into a
    transaction that eliminates, as opposed to transfers, risks. This is a “natural hedge.” Of course, one party
    to a futures contract could be a speculator and the other a hedger. Thus, to the extent that speculators
    broaden the market and make hedging possible, they help decrease risk to those who seek to avoid it.

    There are two basic types of hedges:


    (1) long hedges, in which futures con- tracts are bought in anticipation of (or to guard against) price
    increases, and
    (2) short hedges, where a firm or an individual sells futures contracts to guard against price declines.
    Recall that rising interest rates lower bond prices and thus decrease the value of T-notes futures
    contracts. Therefore, if a firm or an individual needs to guard against an increase in interest rates, a
    futures contract that makes money if rates rise should be used. That means selling, or going short, on a
    futures contract.
    Swap
    A swap is just what the name implies—two parties agree to swap something,
    generally obligations to make specified payment streams. Most swaps today
    involve interest payments or currencies.

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