What Does Futures Contract Mean?

A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a pre-determined price in the future. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. Read more: http://www.investopedia.com/terms/f/futurescontract.asp#ixzz1fPE00am2

orward Contract
What Does Forward Contract Mean? A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date.

Investopedia explains Forward Contract Most forward contracts don't have standards and aren't traded on exchanges. A farmer would use a forward contract to "lock-in" a price for his grain for the upcoming fall harvest. Read more: http://www.investopedia.com/terms/f/forwardcontract.asp#ixzz1fPEXiJSr Fundamentally, forward and futures contracts have the same function: both types of contracts allow people to buy or sell a specific type of asset at a specific time at a given price. However, it is in the specific details that these contracts differ. First of all, futures contracts are exchange-traded and, therefore, are standardized contracts. Forward contracts, on the other hand, are private agreements between two parties and are not as rigid in their stated terms and conditions. Because forward contracts are private agreements, there is always a chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never. Secondly, the specific details concerning settlement and delivery are quite distinct. For forward contracts, settlement of the contract occurs at the end of the contract. Futures contracts are marked-to-market daily, which means that daily changes are settled day by day until the end of the contract. Furthermore, settlement for futures contracts can occur over a range of dates. Forward contracts, on the other hand, only possess one settlement date. Lastly, because futures contracts are quite frequently employed by speculators, who bet

on the direction in which an asset's price will move, they are usually closed out prior to maturity and delivery usually never happens. On the other hand, forward contracts are mostly used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place. Read more: http://www.investopedia.com/ask/answers/06/forwardsandfutures.asp#ixzz1fPEiyXsq

A Forward Contract is a way for a buyer or a seller to lock in a purchasing or selling price for an asset, with the transaction set to occur in the future. In essence, it is a financial contract obligating the buyer to buy, and the seller to sell a given asset at a predetermined price and date in the future. No cash or assets are exchanged until expiry, or the delivery date of the contract. On the delivery date, forward contracts can be settled by physical delivery of the asset or cash settlement. Forward contracts are very similar to futures contracts, except they are not marked to market, exchange traded, or defined on standardized assets. Forward contracts trade over the counter (OTC), thus the terms of the deal can be customized to fit the needs of both the buyer and the seller. However, this also means it is more difficult to reverse a position, as the counterparty must agree to canceling the contract, or you must find a third party to take an offsetting position in. This also increases credit risk for both parties.

What are the uses of forward contracts?

Forward contracts offer users the ability to lock in a purchase or sale price without incurring any direct cost. This feature makes it attractive to many corporate treasurers, who can use forward contracts to lock in a profit margin, lock in an interest rate, assist in cash planning, or ensure supply of a scarce resources. Speculators also use forward contracts to make bets on price movements of the underlying asset. Many corporations and banks will use forward contracts to hedge price risk by eliminating uncertainty about prices. For instance, coffee growers may enter into a forward contract with Starbucks (SBUX) to lock in their sale price of coffee, reducing uncertainty about how much they will be able to make. Starbucks benefits from contract because it is able to lock in their cost of purchasing coffee. Knowing what price it will have to pay for its supply of coffee ahead of time helps Starbucks avoid price fluctuations and assists in planning.

How do forward contracts work?

Forward contracts have a buyer and a seller, who agree upon a price, quantity, and date in the future in which to exchange an asset. On the delivery date, the buyer pays the seller the agreed upon price and receives the agreed upon quantity of the asset.

If the contract is cash settled, the buyer would have a cash gain (and the seller a cash loss) if the spot price, or price of the asset at expiry, is higher than the agreed upon Forward price. If the spot price is lower than the Forward price at expiry, the seller has a cash gain and the buyer a cash loss. In cash settled forward contracts, both parties agree to simply pay the profit or loss of the contract, rather than physically exchanging the asset. A quick example would help illustrate the mechanics of a cash settled forward contract. On January 1, 2009 Company X agrees to buy from Company Y 100 pounds of coffee on April 1, 2009 at a price of $5.00 per pound. If on April 1, 2009 the spot price (also known as the market price) of coffee is greater than $5.00, at say $6.00 a pound, the buyer has gained. Rather than having to pay $6.00 a pound for coffee, it only needs to pay $5.00. However, the buyer's gain is the seller's loss. The seller must now sell 100 pounds of coffee at only $5.00 per pound when it could sell it in the open market for $6.00 per pound. Rather than the buyer giving the seller $500 for 100 pounds of coffee as he would for physical delivery, the seller simply pays the buyer $100. The $100 is the cash difference between the agreed upon price and the current spot price, or ($6.00-$5.00)*100.

Risks of forward contracts

Because no money exchanges hands initially, there is counterparty credit risk involved with forward contracts. Since you depend on the counterparty to deliver the asset (or cash if it is a cash settled forward contract), if the counterparty defaults between the initial agreement date and delivery date, you may have a loss. However, two conditions must apply before a party faces a loss:
1. The spot price moves in favor of the party, entitling it to compensation by the counterparty, and 2. the counterparty defaults and is unable to pay the cash difference or deliver the asset.

Categories: Definitions | Topic

BADLA
What is Carry-Forward System? In common parlance the Carry-Forward system is known as Badla, which means something in return. The Carry Forward system (Badla) of transactions has been in practice for several decades in the Stock Exchange, Mumbai. The Badla serves three needs of the stock market :

It is a quasi-hedging mechanism: If an investor feels that the price of a particular share is expected to go up or down, without giving or taking the delivery he can participate in the possible fluctuation of the share. It is a stock lending mechanism: If he wishes to short sell without owning underlying security, the stock lender steps into the Badla and lends his stock for a charge. It is a financing mechanism: If he wishes to buy the share without paying the full consideration, the financier steps into the Badla and provides the finance to fund the purchase. What is 'Vyaj Badla'? In the Badla a position is carried forward, be it short sale or long purchase. However 'vyaj badla' is a 'badla' that is done without any sale or purchase position for investment in the market. The 'vyaj badla' financier enters into the system to lend money or shares for return. This is measured as interest on the funds made available for one settlement cycle, i.e. one week or a longer period in case of book closure Badla. Similarly 'undha badla' or contango charges are returns paid by stock borrower to stock lender. How is 'vyaj badla' done? On every Saturday in the Stock Exchange, Mumbai, a Badla session is held. The scrip in which there are outstanding positions is listed along with the quantities outstanding. Depending on the demand and supply of money, To start with there is a standard rate and this rate is mostly the closing price of a particular script on the last working day i.e; Friday. If the market is over bought, there is more demand for funds and the BADLA rates tend to be high. However when the market is oversold the BADLA rates are low or even reverse i.e. there is a demand for stocks and the person who is ready to lend stocks gets a return for the same. The

computer screen continuously show the yield, which is available at a particular rate. Depending on the amount you wish to invest the scrips and quantities are selected. The yield is calculated:

Standard Price : 300 Quoted Price : 300.30 Then; 0.30*52 *100 300 What is Book Closure Badla? When the Company's books close (i.e., during Book Closures) there is No Delivery Period wherein there is no exchange of Delivery for about four weeks. The Carry Forward financier has to transfer the shares in his own name and re-deliver after transfer. The returns on Book Closure are hence higher than the average BADLA yield.

What security does he get against his money? He gets equivalent value of shares against the amount lent by him. The shares are kept in safe custody of the Clearing house, as stipulated by SEBI to retain the same until the 'vyaj badla' is released and investor wants his funds back. It is also possible to open a sub-account in investor's name in the Clearing House so that the shares remain in his name and the same cannot be misused. In fact it is not necessary to have the shares in his sub-account. He can exercise his lien based on the contract given by the broker. Is it necessary to select the scrips for the Carry Forward system?

The scrips that have been put in the Carry Forward list are all 'A' group scrips which have a good dividend paying record, high liquidity and are actively traded. It is difficult to get the maximum return if the scrips are specified in advance, based on the demand and supply of money the scrips are to be selected for Carry Forward every week. What about margin, does an investor get margin? The margin is collected by the Exchange from the person who avails of the finance facility and it is kept with the Exchange. This is part of the risk control measures adopted by the Exchange. The 'Vyaj Badla' financier does not get any margin. How safe is the Clearing House? The Clearing House is managed by a company called BOI Share Holding, which is a subsidiary of Bank of India and The Stock Exchange, Mumbai. It has an insurance cover of Rs. 800 crores to make good any loss that occurs due to fire, fraud etc. Further the shares being in investor's sub-account are his property and he can operate the account on his own. What happens if the broker is declared defaulter? The Stock Exchange, Mumbai has a trade guarantee fund of Rs.306 crores (as on 31.3.98) which steps in if a broker defaults. What are the accounting entries to be passed ? Funding through 'vyaj badla' is by booking sale and purchase transactions simultaneously and the difference being the interest component. In the first settlement that an investor enter the system he has a purchase position, however in subsequent settlements he has a sale and so on till the last settlement wherein he would have a sale position. Is the yield guaranteed ?

No the yield can not be guaranteed. In each settlement the yield depends on the demand for and supply of funds. However, it is seen that over a period of time i.e. 3 to 6 months 'vyaj badla' has definitely out-performed other available comparative avenues of investment. What is the depth of the market ? In every settlement the Carry Forward value was about Rs. 1,200 crores plus in March 1998 and it is increasing every settlement. Only the Stock Exchange, Mumbai offers the BADLA facility presently. The Stock Exchange, Mumbai is rapidly expanding its BOLT (BSE on line trading system) network nation wide and volumes are expected to increase. What is transaction charge ? Roughly brokerage charged by a broker is 1/8 to 1/10 of the interest earned by investor, this includes the cost of stamps that brokers have to affix on the contract note that they issue at the beginning of each settlement, the turnover charges to be paid to the Stock Exchange and other turnover linked charges that are paid to the Exchange like contribution to investors protection fund, insurance premium etc. This also goes to service the capital that is maintained by broker members for meeting enhanced capital adequacy norms.
Badla versus futures
B. Venkatesh SEBI has banned badla trading and proposes to introduce futures in its place. What is badla trading and how does it compare with futures? Suppose you buy 1,000 shares of Infosys at Rs 3,500, your cash outflow is Rs 35 lakh. Instead of paying cash, you can ask your broker to find a borrower to finance your trade. This process of buying stocks with borrowed money is badla trading. The stock exchange acts as an intermediary between you and the actual lender. You will be charged an interest rate for borrowing, which will be determined by the demand for that

stock under badla trading. Thus, higher the demand for Infosys under badla trading higher will be the interest rate. You can keep your borrowing unpaid for a maximum of 70 days, after which you will have to repay the badla financier through the exchange. Those familiar with futures will immediately recognise its similarity with badla trading. Suppose SEBI introduces single-stock futures, you can buy, say, 10 Infosys futures that will at maturity give you 1,000 Infosys shares on payment of money. You will initially pay a margin and buy 10 futures contract. This is similar to the broker placing a margin on badla trades. The futures contract will be marked-to-market on a daily basis. This means that if you buy Infosys futures today at Rs 3,750 and the price in the futures market goes up to Rs 3,800 the next day, you will have to deposit with your broker Rs 50 (3,800-3,750) times 10 (the number of futures contract). You will likewise receive money if the futures price goes below Rs 3,750. Of course, in badla trading, it is the broker who has to maintain a marked-to-market margin and not the buyer/seller as in the case of futures. In essence, however, both futures and badla system allow investors to buy stocks without huge cash outflow. In other words, both help in leveraged trades. It is, perhaps, due to this similarity that SEBI has decided to ban badla and introduce futures in line with the trends in developed countries.

Futures contract
From Wikipedia, the free encyclopedia In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today (the futures price or the strike price) with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "long", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "short". The terminology reflects the expectations of the parties -- the buyer hopes or expects that the asset price is going to increase, while the seller hopes or expects that it will decrease. Note that the contract itself costs nothing to enter; the buy/sell terminology is a linguistic convenience reflecting the position each party is taking (long or short). In many cases, the underlying asset to a futures contract may not be traditional commodities at all that is, for financial futures the underlying asset or item can be currencies, securities or financial instruments and intangible assets or referenced items such as stock indexes and interest rates. While the futures contract specifies a trade taking place in the future, the purpose of the futures exchange institution is to act as intermediary and minimize the risk of default by either party. Thus the exchange requires both parties to put up an initial amount of cash, the margin. Additionally, since the futures price will generally change daily, the difference in the prior

agreed-upon price and the daily futures price is settled daily also. The exchange will draw money out of one party's margin account and put it into the other's so that each party has the appropriate daily loss or profit. If the margin account goes below a certain value, then a margin call is made and the account owner must replenish the margin account. This process is known as marking to market. Thus on the delivery date, the amount exchanged is not the specified price on the contract but the spot value (since any gain or loss has already been previously settled by marking to market). A closely related contract is a forward contract. A forward is like a futures in that it specifies the exchange of goods for a specified price at a specified future date. However, a forward is not traded on an exchange and thus does not have the interim partial payments due to marking to market. Nor is the contract standardized, as on the exchange. Unlike an option, both parties of a futures contract must fulfill the contract on the delivery date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position can close out its contract obligations by taking the opposite position on another futures contract on the same asset and settlement date. The difference in futures prices is then a profit or loss.