Financial Futures

Financial futures are futures contract based on financial instruments such as Treasury bonds, currencies and CDs. These underlying assets are contracted to be bought at a specified price on a specified date. Financial futures may also involve contracts on short term interest rates (STIR).

How are Financial Futures Traded?

Financial futures are highly standardized contracts that are traded in organized futures exchanges across the world. The mode of trade is open outcry on the floor of these exchanges. Examples include the International Money Market in Chicago and London International Financial Futures Exchange (LIFFE) in London.

The contractual agreement stipulates the terms of the agreement such as the number of units of the financial instrument, the names and details of the parties to the contract, the futures price and the specified future delivery date. The transfer of profits or losses accrues on the basis of the difference between the settlement price and the financial futures price.

For instance, a buyer who purchases a June 3-month Eurodollar contract is committing to deposit 1 million Eurodollars in June for 3 months. Additionally, the deposit would be done at an interest rate that is agreed upon at the time of the contract. The actual procedure, however, depends on the exchange in which the trading is conducted. The movements of the price are tracked in terms of ‘ticks,’ which represent the minimal price fluctuations.

The buyers or sellers of the futures contract are required to deposit an initial amount called the margins. This is deposited with the clearing house of the futures exchange. This is a fixed amount which is held with the futures exchange till the position is held.

Benefits of Financial Futures

Financial futures are hedging instruments that can help realize high profits and protect against risks. Moreover, financial futures offer the following:

• High liquidity.
• An opportunity to avoid the actual transfer of financial instruments.

Risks of Financial Futures

The risks associated with financial futures are:

• High losses are possible if investors overtrade or trade without a plan.
• Insider trading can be a problem in futures trading, which can harm the profit prospects of other traders.

Investors with a high risk appetite tend to like financial futures and their potential for short term profits.