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FUTURES Introduction Futures markets were designed to solve the problems that exist in forward markets.

A futures contract is a agreement between two parties to buy or sell as asset at a certain time in the future at a certain price. However, unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. Introduction o Futures in India: The first derivative product to be introduced in the Indian securities market is going to be INDEX FUTURES
A futures contract on a stock or financial index. For each index, there may be a different multiple for determining the price of the futures contract. Features of Future Contracts:

Are entered into through exchange, traded on exchange and clearing corporation/house provides the settlement guarantee for trades. Are of standard quantity, standard quality (in case of commodities). Have standard delivery time and place. Economic Functions of Futures Markets.

The primary economic function and raison prevent of futures markets is the hedging function also known as the price insurance, risk-shifting or risk transferable function. Futures markets provide a vehicle by which participants can hedge i.e., protect themselves from adverse price movements in a commodity or financial instrument in which they face a price risk. The four secondary functions are mentioned below. Price Discovery Function: Futures markets provide a mechanism by which diverse and scattered opinions of the future are coalesced into one readily discernible number, which provide a consensus of knowledgeable thinking. Organized spot market perform a price discovery function too, but only in respect of the spot (i.e., current) price. Financing Function: The use of standardized contracts makes it easier to raise finance against stocks of commodities, since lenders have an assurance of standardized quality and quick liquidity. Liquidity Function: futures markets operate on a fractional margin whereby the buyer and seller deposit only traction of the contract value (say 10%) at the time of entering into it. This enables traders to buy and sell a much larger volume of contracts than in a spot market, and makes markets liquid, so that large transactions can put through with ease.

Price Stabilization Function: Futures markets generally exercise a stabilizing influence on spot prices by reducing the amplitude of short-term fluctuations.

The classical view Constructive Speculation: Forward contracts are often confused with contracts. The confusion primarily because both serve essentially the same economic function risk in the presence of future price uncertainty. However, futures are a significant improvement over the forward contract as they eliminate counter party risk and offer more liquidity. Its distinctions listed in the following table: Features Operational Mechanism Contract Specifications Counter party Risk Liquidation Profile Price Discovery Poor, markets are disjointed. Future contract Traded on exchange Contracts are standardized contracts. Exists Exists, but assume by clearing Corporation/house. Poor Liquidity as contracts are Very high Liquidity as contracts is tailor maid contracts. standardized contracts as Poor; as markets are Better, as fragmented markets are fragmented. brought to the common platform. Forward contract Not traded on exchange Differs from trade to trade

Risk management through Futures: Basic objective of introduction of futures is to manage the price risk. Index futures used to manage the systemic risk, vested in the investment in securities.