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FUTURES CONTRACTS - October 8th, 2010


The problems associated with forward contracts lead to the emergence of Futures Contracts. A futures contract is a standardized contract between 2 parties where one of the parties commits to sell and the other to buy a stipulated quantity (and quality, where applicable) of a commodity, currency, security, index or some other specified item at an agreed price on or before a given date in the future.

Futures contracts on commodities have been traded for long. In the USA, for instance, such contracts began trading on the Chicago Board of Trade (CBOT) in the 1860s. However, in the past 3 decades, financial futures contracts have been evolved. The financial futures, probably, are a very significant financial innovation.

They encompass a variety of underlying assets – securities, stock indices, interest rates and so on. The beginnings of financial futures were made with the introduction of foreign currency futures contracts on the International Monetary Markets (IMM) – a division of the Chicago Mercantile Exchange (CME) – in May 1972. Subsequently, interest rates futures – where the contract is on an asset whose price is dependent solely on the level of interest rates – were introduced on the CBOT in October 1975.

A futures contract in treasury bonds is one of the most actively traded futures contracts in the world. An important development took place in the world of futures contracts in 1982 when stock index futures were introduced in USA. Although some futures contracts on indices were traded in Europe in the 1970s.

It was in America only that a formal beginning was made when the Kansas City Board of Trade (KCBT) introduced stock index futures with the ‘value line index’ serving as the underlying index.

A futures contract on a stock index has been a revolutionary and novel idea because it represents a contract based not on a readily deliverable physical commodity or currency or other negotiable instrument.

It is instead based on the concept of a mathematically measurable index that is determined by the market movement of a predetermined set of equity stocks.

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