Forwards and Futures
Forwards and Futures are derivative instruments that involve two parties who agree to buy or sell a specific asset at a set price by a certain date in the future.
Over the years, forwards and futures have become a central component of the financial economy, especially in the commodities, fixed income and currencies space.
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#1. Which of the following statements about forwards and futures is correct?
A forward contract is a private agreement that is settled at the end of the contract. A futures contract, on the other hand, has standardized terms and is traded on an exchange where prices are settled each day until the end of the contract.
#2. How far back can forward contracts be traced?
Forward contracts may even have occurred earlier than Greek and Roman times and have been common in Europe since the Middle Ages.
#3. Why did forward contracts emerge?
While the other reasons are valid as well, forward contracts came into being primarily because of difficulties in transport and communication, trading was often based on samples which made forward contracting essential.
#4. What is one of the disadvantages of futures contracts?
As the end of the futures contract approaches, it becomes less attractive and may even end up being a completely worthless investment.
#5. Future contracts are a very stable form of investment. True or False?
The prices of futures contract can rise and fall daily – sometimes within minutes of the last change. Hence futures are meant more for hedging purposes than for long term investments
#6. What is backwardation? When the …
Backwardation occurs when demand for an asset is currently higher than the contracts that will mature on the futures market. This is specifically what happened to the oil market during most of 2021 and early 2022. Due to shortages of supply, demand for physical oil outstripped supply causing current oil prices to rise more than future oil prices.
#7. Which of the following is a legitimate future that is traded on the Chicago Mercantile Exchange?
Hurricane futures are used by business owners, insurance companies, utility service suppliers and individual house owners.
#8. The trading of futures contracts on which of the following crops is banned in the United States?
During 1955 two onion traders, Sam Siegel and Vincent Kosuga, bought so many onions and onion futures that they controlled 98% of the available onions in Chicago. Then they took short positions on a lot of onion contracts. Their escapade actually caused onion shortages in parts of the US and drove many farmers to bankruptcy. Afterwards public outcry led to the US congress passing a bill which excluded onions from the definition of “commodity”, leading to the ban on onion futures.
#9. Which is the only group to sometimes trade in the box office performance of Hollywood films?
Even though trading in box office futures is illegal, due to fears of insider trading and price manipulation, the Iowa Electronic Markets sometimes does it. They get away with it because they are operated by the University of Iowa, who runs it for educational and research purposes.