In today’s financial markets, many people who are new to investing wonder, what are financial futures? A quick definition would be to say that financial futures are actually futures contracts which are based on financial instruments such as Treasury bonds, CDs, currencies or indexes. Mostly though, a financial future is simply defined as a future contract on a short term interest rate. All future contracts are different and can vary, but are often referred to as the index interest rate, the pound in three months, or U.S. dollars.
What you must remember is that a financial futures contract requires the buyer to purchase a good or a seller to sell an asset, such as financial instruments which can be bonds and currency at a pre-specified price and date in the future. Financial futures contracts contain the details which are relevant to a transaction such as the quality and quantity of the underlying securities, which have been standardized to be consistent with the futures exchange to facilitate trading.
Some futures contacts may ask for an actual physical delivery of the financial instrument itself, and all other agreements are simply settled with cash. The commodity markets are characterized by their ability to make good use of leverage, which is important in relation to the stock market and other investments. Futures can be used either to speculate or hedge movements in commodity prices. To clarify, for example, an investor could use Bonds futures to lock in a certain price and then reduce the loss. This type of activity would protect against a loss. In addition, anyone can speculate on the outcome of the price movement of a financial instrument by going long or short when using futures.
The financial futures contracts are traded on a futures market. The financial futures contracts are not direct securities such as stocks, bonds, rights or warrants, but they are still valid securities and financial instruments. They are actually a form of derivatives. Again, they are financial contracts made with each party agreeing to do something in the contract.
The party which is agreeing to buy the underlying asset in the future is the party that is assuming the long position, while the party who is agreeing to sell the asset in the future is the one who is assuming the short position. For financial instruments, these underlying assets are currencies, securities or financial instruments and other intangible assets or property such as stock indexes and interest rates.
About the author: Catherine C. Harris is an author who specializes in investments with a passion for financial futures.
Credits: Image courtesy of Svilen Milev.