forward market, futures market


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forward market, futures market

or

forward exchange market

a market which provides for the buying and selling of FINANCIAL SECURITIES (shares, stocks), COMMODITIES (rubber, tin, etc.) FOREIGN CURRENCIES, DERIVATIVES and SWAPS for delivery at some future point in time, as opposed to a SPOT MARKET which provides for immediate delivery Forward positions are taken by traders in a particular financial asset or commodity whose price can fluctuate greatly over time, in order to minimize the risk and uncertainty surrounding their business dealings in the immediate future (i.e. hedge against adverse price movements), and by dealers and speculators (see SPECULATION) hoping to earn windfall profits from correctly anticipating price movements.

Traders seek to minimize uncertainty about future prices by buying or selling futures, particularly OPTIONS, i.e. contracts that promise to buy or sell a commodity or financial asset at a price agreed upon now for delivery at some later point in time, usually within a three-month period. For example, a producer of chocolate could contract to buy a given amount of cocoa at today's price plus a percentage risk premium for delivery in two months' time. Even if the price of cocoa were to go up markedly, the manufacturer knows that he is still able to buy at the (lower) contract price, and is thus able to plan his raw material outlays accordingly Similarly, the producers of cocoa can contract to sell the commodity at an agreed price now for delivery in the near future in order to cover themselves against adverse price changes.

In between the original buyers and producers, using futures as a hedge to minimize risk, stand the various dealers and speculators who do not themselves actually physically hold commodities and financial assets but buy or sell the paper contracts to such items according to their view of probable price movements.

Forward prices reflect anticipated future demand and supply conditions for a financial security, foreign currency or commodity being traded. Specifically, the forward prices will be based partially on current spot prices but will also take into account interest rate and inflation rate trends. The difference between the current spot rate of a foreign currency and the forward exchange rate constitutes the ‘forward margin’. The forward margin can be at either a discount or a premium to the spot rate.

The EUREX and the LONDON INTERNATIONAL FINANCIAL FUTURES MARKET (LIFFE), are the largest European Union centres for forward dealings in securities and commodities. The forward markets in the UK are regulated by the FINANCIAL SERVICES AUTHORITY in accordance with various standards of good practice laid down under the FINANCIAL SERVICES ACT 1986. Globally, the Chicago Board of Trade and the Chicago Mercantile Exchange are the world's largest forward markets. See COMMODITY MARKET, FOREIGN EXCHANGE MARKET, STOCK MARKET, CONTANGO, COVERED INTEREST ARBITRAGE, EXCHANGE RATE EXPOSURE, EQUILIBRIUM MARKET PRICE.

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