Futures contract

Definition

A futures contract is a standardized legal agreement to buy or sell a specific commodity or financial instrument at a predetermined price at a specified time in the future. These contracts are traded on exchanges and are primarily used for hedging risk or speculation.

5 Must Know Facts For Your Next Test

1. Futures contracts are standardized, meaning they have set terms regarding quantity, quality, and delivery date.
2. Traders use futures contracts to hedge against commodity price fluctuations, reducing uncertainty.
3. The initial margin is required to enter into a futures contract, which acts as collateral.
4. Futures contracts can be settled either through physical delivery of the asset or cash settlement.
5. Speculators in the futures market aim to profit from price movements without intending to take delivery of the underlying asset.

Review Questions

• What is the primary purpose of using a futures contract?
• How do standardization and exchange-trading benefit participants in the futures market?
• What are the two methods by which futures contracts can be settled?

Related terms

Hedging: The practice of making an investment to reduce the risk of adverse price movements in an asset.

Margin: The amount of money required to open and maintain a position in a futures contract.

Spot Price: The current market price at which an asset can be bought or sold for immediate delivery.