A futures contract is essentially a standardised forward contract, except that the deal is made through an organised and regulated exchange rather than being negotiated directly between two parties. These exchanges specify certain features to standardise the product, and also provides the guarantee that the contract will be honoured.

Based upon settlement futures contracts can be classified as:

  1. Physically Delivered Contract – one side agrees to deliver a commodity or asset on a future date (or within a range of dates) at a fixed price, and the other party agrees to take delivery.
  2. Cash-Settled Futures Contract – the difference between the fixed price and the actual market value of the underlying at expiry is settled in cash.

Traditionally there are three key differences between forwards and futures, although as discussed later the distinctions have blurred somewhat in recent years.

  1. A futures contract is guaranteed against default.
  2. Futures are standardized, in order to promote active trading.
  3. Profits and losses on futures are realized on a daily basis to prevent them from accumulating.
Categories: Derivatives


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