What Are Futures?

In the world of finance, there are many uncommon and niche terms used, which are alien to the rest of the world. 'Futures' is one of those terms that is used to identify a form of a financial contract. Futures Contract is a standard contract, to buy or sell a certain asset at a certain date in the future, at a specific time. Usually futures contracts are traded on a futures exchange.

The futures contract detail the quality, quantity and the price of the underlying asset. Usually there are many motives for making a futures contract. Since it is a business agreed to be performed in the future at a specific time and for a specific price, the buyer of the underlying asset is protected against the price fluctuations of the asset in the market. This may result in profit or sometimes, a loss to the contract holder as there is an obligation to buy or sell at the specified price.

Many contracts in the financial world assign the 'right' to do something to the contract holder. Futures contracts differ in this aspect by assigning 'right' and 'obligation' to the contract holders (both parties) for performing what the futures contract details. Some futures contracts call for a physical delivery of the asset and others are settled in cash.

Many assets, especially commodities are subjected to futures contracts in futures exchanges. As an example, there is seller who would like to sell a high volume of corn at the next harvest. Although, the corn is not produced yet, the producer wants to make sure that a proper price is paid for the corn in the future. Then there is a buyer who is looking for corn from the next crop, who will be willing to pay the current market price for it or something similar. In this case, the seller and the buyer can form a futures contract on a specific price, through which both the seller and the buyer are protected against the high price changes.

There are two main traders of futures; hedgers and speculators. Hedgers are interested in the asset subjected to the futures contract and they seek to hedge out the risk of price changes. Speculators usually have no interest or practical use of the assets subjected to the futures contract. They usually buy futures for selling them later with profit to interested parties.

Futures and 'Forwards' looks the same in the finance market but they have two significant differences. Firstly, Futures are traded in Futures exchanges, but forwards are traded over the-counter. Secondly, Futures have a less credit risk while forwards carry a high risk.

Zoran Maksimovic is an author focused on investing for beginners. To see more articles about fundamentals of investing visit his site Investing made easy.

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