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Futures Contract

A futures contract is a standardized agreement to buy or sell a specific asset, such as commodities, currencies, or financial instruments, at a predetermined price on a future date. Futures contracts are traded on exchanges and are used by investors and companies for hedging or speculative purposes. These contracts help manage price risk by locking in prices for future transactions, providing a tool for managing exposure to market volatility.

Example

A coffee producer uses a futures contract to lock in a price for coffee beans to be delivered in six months, protecting against potential price declines that could impact revenue.

Key points

• Standardized agreement to buy or sell an asset at a future date and price.

• Traded on exchanges for hedging and speculative purposes.

• Helps manage price risk by locking in future prices.

Quick Answers to Curious Questions

Futures allow companies to hedge against price fluctuations, securing prices for raw materials or products, stabilizing costs, and protecting profit margins.

Futures are standardized and traded on exchanges with clearinghouses, while forwards are customized agreements traded OTC with higher counterparty risk.

Risks include market risk, leverage risk, and the potential for margin calls, which can lead to significant financial losses if market prices move unfavorably.