9.3.1Financial futures

The most common products underlying futures contracts are foreign currencies

(exchange rates), interest rates on notional amounts of capital, and stock exchange

indices. The futures contracts are themselves tradable – that is, they can be bought and

sold in futures markets. To increase their tradability, futures contracts are standardised

in terms of both time period and amount. They specify the quantity and quality of

the underlying product, the agreed price and the date of delivery.

Futures contracts:Legally binding agreements to deliver, or take delivery of, a

commodity or a nancial instrument at some specied future date.

Thus, the Sterling Futures contract (see Box 9.1) offered by the Chicago Metal

Exchange (CME) species an amount of £62,500, while each Japanese Yen Futures

contract offered by CME is for ¥12.5 million. Interest rate futures specify the amount

of the notional bond and its interest-rate coupon, for instance, a $100,000 nominal

20-year treasury bond with a 7 per cent coupon. As long as contracts are for relatively

small amounts, this standardisation does not much reduce the exibility of the

market since an investor can vary the amount of his exposure by buying or selling

a number of contracts on the same underlying product for the same period.

Most nancial futures contracts offer a choice of four delivery dates per year.

There are a number of delivery details, including lists of eligible assets that satisfy

the delivery requirements of a contract, and methods of determining the nal settle-

ment price. However, delivery does not usually occur as buyers and sellers of futures

contracts are not normally end-users of the underlying product. Traders using futures

to hedge against risk to which they are exposed in the cash market are seeking to

lock in to existing exchange or interest rates on future transactions. In such cases, the

period for which the hedge is needed is unlikely to coincide with the period of the

futures contract. Once a rm has traded out of its open position in the cash market,

it no longer needs the hedge in the futures market.

Financial futures may also be traded by speculators who wish to prot from the

rises or falls they expect to occur in interest rates, exchange rates or stock exchange

indices. Through futures, they can take a view about trends in cash markets without

having to purchase the underlying product. A speculator who felt that interest rates

were likely to rise or a currency’s value decline would go short in the relevant asset

by selling a futures contract. Traders who are using the futures market to create an

open position in this way usually close the position once they have achieved their

prot objectives. If it does not seem likely that they will make the hoped-for prot,

they will probably cut their losses before delivery is due.

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