Chapt 1 Flashcards
A cash forward contract differs from a futures contract in that the futures contract…
is not personally negotiated between the buyer and the seller
A ___________ futures contract is an agreement that’s entered into between a buyer and seller on the floor of an exchange.
commodity
Transaction that involves the agreement between the buyer and seller for delivery of a specified amount of the cash commodity to be delivered at a specified time, price and delivery point
cash forward transaction
this contract is negotiated on an exchange, which is a single, central market on which all purchase and sale orders are channeled
futures contract
The cash forward transaction is what type of agreement between the buyer and the seller?
non-transferable agreement; which means both parties have obligations
FUT contracts are not negotiated between the buyer and the seller. Who negotiates them?
the broker who represents the buyer and the seller, respectively
this type of contract is set by a particular exchange and includes the size, point from which delivery will be made, grade of the commodity and price
commodity futures contract
the standard grade that may be delivered in a commodities contract is…
the basis grade
Outside of the basis grade, the exchange will allow the seller to deliver a substitute grade. Explain both options
grade that’s lower in quality at a discounted price
grade that’s higher in quality for a premium price
This exists when an individual or group of individuals who are acting in concert accumulates all, or substantially all, of the available supply of a commodity
corners
With control of the cash commodity, one is able to dictate the price that a seller must pay for the cash in order to make delivery on his/her short position
squeeze
refers to a person who has an actual cash position
long
used to describe a person who has an obligation to deliver the cash but doesn’t own it
short - this person is “short” the cash and will need to buy it at a later date
the establishment of a futures position that’s opposite the cash
hedge
a hedge is the establishment of a futures position that’s opposite the cash. what is its purpose?
to establish a temporary substitute for a cash market transaction that will be made at a later date; to reduce/mitigate risk
What are the 6 benefits provided by the Futures Exchange?
- hedging is allowed
- reduction in price of the commodity to public
- central point to channel risk capital of the speculator
- producer or user can obtain credit from banks/lenders at more favorable rates if positions are hedged
- provides focal point where all orders are sent
- provides an Alternative market for whoever wants to buy or sell the commodity
**Hedge, reduction, central point, credit, focal point, Alternative
individual who buys a commodity if he/she anticipates a price rise or sells a commodity if he/she anticipates a price decrease; assumes the risk a hedger is trying to avoid
describe the position this person takes on both a long & short
speculator
long position (buy futures) when prices will rise
short position (sell futures) when prices fall
Who has the responsibility to supervise trading in commodity futures?
Commodity Futures Trading
Commission (CFTC) - a gov agency
In order to be a member firm of an exchange, a firm must be associated with at least…
one individual who owns a membership.
The CFTC allows exchanges to regulate themselves (handles complaints and assesses appropriate penalties), but the regulation is
subject to CFTC review
What are the 2 conglomerate firms that run FUT exchanges?
CME (Chicago Mercantile Exchange) & ICE (Intercontinental Exchange)
settles disputes between members, member firms and the public. all parties involved must voluntarily agree to submit the dispute to this committee
arbitration
committee that investigates business practices against members and prevents price manipulation; supervises the conduct of members as well as member firms and their employees to ensure compliance
business conduct committee
how is trading conducted on the floor of an exchange?
“open outcry” - announce in a loud and clear voice
establishes rules regarding floor trading and settles disputes that arise between members; ensures all transactions are conducted on the floor of the exchange
floor committee
members who execute the orders on a floor
floor brokers
members who trade for their own accounts (and risk); typically establish and close in the same trading session
floor traders AKA locals or scalpers
those who hold positions for more than one session are considered “position traders”
3 ways you have a successful exchange market:
- large number of participants
- minimum gov control for prices to reach natural level without artificial influences
- commodity must be on that is easily graded and standardized
a market has few participants - what is the market referred to and explain the spread expectations
inefficient or “thin market” AKA illiquid or volatile market
the spread between bids and offers will widen, and be wide, and there will be large fluctuations between successive transactions
a market has many participants - what is the market referred to and explain the spread expectations
efficient AKA continuous or liquid
there is small variations between bids and offers and there will be small variations between successive transactions
this type of contract is a legally binding contract and always requires the original buyer or seller to make or take delivery
forward contract
