Many people wonder that What is a futures contract?? Good Risks of Futures Contracts How? Let's find out with HVA today.
What is a futures contract?
So What is a futures contract??
It can be said that futures contracts in Vietnam is a type of derivative security, and in which the seller and the buyer will sell or buy a certain type of asset at a certain time in the future at a certain price agreed upon today. And futures pricing is a very complex process and requires a deep understanding of the factors that affect the price of the underlying asset and other financial factors such as interest rates, exchange rates or market volatility.
A forward contract is a type of futures contract, as opposed to a spot contract, which is for delivery within two days of the contract being signed. A forward contract will have a delivery date that is further from the contract date. The difference between the forward price and the spot price is called a premium if the forward price is higher or a discount if the forward price is lower.
People can also use futures contracts to speculate on future prices, but in some cases the main purpose of the contract is to avoid exposing the asset to future price and interest rate risks.
Basic futures contracts will include two main types: forward contracts and standard forward contracts, also known as futures contracts. Forward contracts are agreed upon between the buyer and seller without going through a transaction. Meanwhile, the standard forward contract will be agreed upon between the buyer and seller through a centralized exchange.
So what is a foreign currency futures contract? Let's answer right away as well as review example of foreign currency futures contract to understand better.
It can be said that a foreign currency futures contract is a type of agreement between two parties, in which one party commits to buy and the other party sells a certain amount of foreign currency at a specified time in the future at a previously agreed exchange rate.
A specific example can be considered as follows: A Vietnamese export company has a shipment, it is about to be exported to the US, and will receive payment in USD within the next 3 months. To avoid exchange rate risk, this company decides to sign a foreign currency forward contract with the bank.
Features of futures contracts
After research What is a futures contract? There are also many individuals who wonder more clearly about futures contracts, especially its characteristics. And below are also the most typical characteristics of Features of futures contracts.
- One thing that a futures contract never violates is that on the day both parties sign the contract, neither party will make payment nor exchange the underlying asset, but this activity will be performed on the maturity date. And until the date derivative maturity The parties must comply with the agreement stated in the contract and must not violate it.
- The futures contract will be agreed upon and then signed by both parties and this will not go through any intermediary and without any fees being paid.
- And the underlying asset is any asset that does not need to be standardized in terms of volume, quality or value as in a futures contract.
- Futures contracts are not like other types of contracts in that they are not listed or priced on a centralized market like futures contracts and are only traded on the OTC market.
- Those who enter into a futures contract may close out a position by opening an opposite position in a similar futures contract.
- Futures contracts will not implement margin and low liquidity of futures contracts will lead to higher risk.
Advantages and disadvantages of futures contracts
Here is it Advantages and disadvantages of futures contracts that you can refer to:
Advantages of futures contracts
For a business, a futures contract is used as a tool to hedge against risks and to fix the business's income or payments at a predetermined price regardless of fluctuations in the underlying asset in the market.
In addition, because futures contracts can only be agreed upon by two parties, they will not be bound by mandatory factors like other types of contracts such as time, volume of transactions, and contract value, so buyers and sellers can change them flexibly and more appropriately to market needs.
Disadvantages of futures contracts
The first disadvantage of this type of contract is that it is quite illiquid, so buyers and sellers will not be able to easily transfer their positions in the contract before the expiration date. For example, the parties cannot sell the contract if they find it unprofitable, and they cannot cancel the contract if they do not need the underlying asset or when they feel disadvantaged.
In addition, a limitation of futures contracts that needs to be mentioned is that one party to the contract will not be able to perform the contract.
What are the risks of futures contracts?
Parties who decide to enter into a futures contract will face two types of Risks of Futures Contracts The most common are liquidity risk and payment risk.
- Liquidity risk: It can be said that the futures market will not be developed as much as futures contracts and especially futures contracts in Vietnam. Since it is not listed on any exchange but can only be a separate contract between two parties, the futures contract is therefore not traded on the market and leads to low liquidity. If in case of high risk or change in demand for the underlying asset, transferring the contract or closing the contract with an opposite position becomes very difficult or impossible.
- Payment risk: Firstly, there will be no margin between the parties and next, there is no intermediary to take on the task of clearing or the profit or loss of the futures contract will be paid only when the contract expires. Therefore, the settlement risk of the futures contract is high if placed in the case that the futures contract can hedge against these types of risks.
The above article by HVA Group has provided quite a lot of useful knowledge about what a futures contract is. If you are an investor interested in commodity derivatives, you can also contact HVA. We promise to update the latest information about market fluctuations as well as the most accurate content for you. HVA wishes you a successful investment experience.
