in any other trade, the futures trade has to have a market to facilitate buying and selling. As the futures markets involve the operation and execution of financial deals of an enormous magnitude, their efficiency has to be of the highest quantity. Not only the size of the monetary operation that a futures market handles but also the critical significance it has on the equilibrium of the commodities / stocks is what makes the operation of the market so crucial.
PURPOSE OF A FUTURES MARKET
Futures markets provide flexibility to an otherwise rigid spot market because of their very concept, which allows a wholistic approach to the price mechanism involved in futures contracts. The future price of a commodity is a function of various commodities related and market related factors and their inter-play determines the existence of a futures contract and its price. Futures markets are relevant because of various reasons, some of which are as follows:
1. Quick and Low Cost Transactions:
Futures contracts can be created quickly at low cost to facilitate exchange of money for goods to be delivered at future date. Since these low cost instruments lead to a specified delivery of goods at a specified price on a specified date, it becomes easy for the finance managers to take optimal decisions in regard to protection, consumption and inventory. The costs involved in entering into futures contracts is insignificant as compared to the value of commodities being traded underlying these contracts.
2. Price Discovery Function:
The pricing of futures contracts in corporates a set of information based on which the producers and the consumers can get a fair idea of the future demand and supply position of the commodity and consequently the future spot price. This is known as the ‘price discovery’ function of future.
3. Advantage to Informed Individuals:
Individuals who have superior information in regard to factors like commodity demand-supply, market behaviour, technology changes, etc., can operate in a futures markets and impart efficiency to the commodity’s price determination process. This, in turn, leads to a more efficient allocation of resources.
4. Hedging Advantage:
Adverse price changes, which may lead to losses, can be adequately and efficiently hedged against through futures contract.
An individual who is exposed to the risk of an adverse price change while holding a position, either long or short a commodity, will need to enter into a transaction which could protect him in the event of such an adverse change. For eg, a trader who has imported a consignment of copper and the shipment is to reach within a fortnight may sell copper futures if he foresees fall in copper prices.
In case copper prices actually fall, the trader will lose on sale of copper but will recoup through futures. On the contrary if prices rise, the trader will honour the delivery of the futures contract through the imported copper stocks already available with him.
Thus, futures markets provide economic as well as social benefits. Through their functions of risk mgt. and price discovery.
PURPOSE OF A FUTURES MARKET
Futures markets provide flexibility to an otherwise rigid spot market because of their very concept, which allows a wholistic approach to the price mechanism involved in futures contracts. The future price of a commodity is a function of various commodities related and market related factors and their inter-play determines the existence of a futures contract and its price. Futures markets are relevant because of various reasons, some of which are as follows:
1. Quick and Low Cost Transactions:
Futures contracts can be created quickly at low cost to facilitate exchange of money for goods to be delivered at future date. Since these low cost instruments lead to a specified delivery of goods at a specified price on a specified date, it becomes easy for the finance managers to take optimal decisions in regard to protection, consumption and inventory. The costs involved in entering into futures contracts is insignificant as compared to the value of commodities being traded underlying these contracts.
2. Price Discovery Function:
The pricing of futures contracts in corporates a set of information based on which the producers and the consumers can get a fair idea of the future demand and supply position of the commodity and consequently the future spot price. This is known as the ‘price discovery’ function of future.
3. Advantage to Informed Individuals:
Individuals who have superior information in regard to factors like commodity demand-supply, market behaviour, technology changes, etc., can operate in a futures markets and impart efficiency to the commodity’s price determination process. This, in turn, leads to a more efficient allocation of resources.
4. Hedging Advantage:
Adverse price changes, which may lead to losses, can be adequately and efficiently hedged against through futures contract.
An individual who is exposed to the risk of an adverse price change while holding a position, either long or short a commodity, will need to enter into a transaction which could protect him in the event of such an adverse change. For eg, a trader who has imported a consignment of copper and the shipment is to reach within a fortnight may sell copper futures if he foresees fall in copper prices.
In case copper prices actually fall, the trader will lose on sale of copper but will recoup through futures. On the contrary if prices rise, the trader will honour the delivery of the futures contract through the imported copper stocks already available with him.
Thus, futures markets provide economic as well as social benefits. Through their functions of risk mgt. and price discovery.