Futures for a Bright Future
Future contracts incorporate all the details pertaining to the underlying asset's quality and quality. They are standardized so that they can be traded on a futures exchange and necessitate the asset's physical delivery; some of the suture contracts, are however, settled in cash. An investor uses futures contracts specifically to speculate and hedge.
Speculation:
When you are speculative, you do not make profits only when the market is buoyant, but also when it is down. Speculation enables you to track the direction in which the stock is moving and determine the movement's timing and magnitude. Consequently, you get a fair idea about how much is the stock's price likely to change and within what time frame. Hence, there are a lit of chances of your predictions being right and you make really big bucks.
When you are a large institution and control as large as a hundred shares with one contract, you are bound to book substantial profits with the slightest upward movement in process.
Hedging:
In financial terms, hedge refers to an investment that is made to minimize the potential risks in another investment. Hedging means a strategy that is specifically designed to limit a stock's exposure to any sort of business risk, while allowing the business to continue to reap benefits from the investment.
A hedger may invest in a security that, according to him, is under-priced in relation with its fair value, and then combine it with a short sale of one or more related securities. The hedger, therefore, is concerned only with under-priced security and its appreciation in relation with the market.
Some risks are inherent for specific businesses and are inevitable. For instance, fluctuations in oil prices are inevitable for oil companies, as they prices of crude is benchmarked to international prices. However, other risks are unwanted and must be hedged; for instance, inventory in a shop must be hedged against fire or any other disaster through a fire insurance or other suitable contracts.
The actual delivery rate of goods under the future contracts is very low because investors avail of speculating and hedging benefits even when they do not hold these contracts until their expiry period and delivery of goods. For instance, if the investor is long on such a contract, he can go short on a similar contract to exit. This is similar to selling a stock in the equity markets closing the trade.
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