Futures Contracts

A futures contract is very similar to a forward contract, and they are used to do the same thing. However, they differ in the structure of agreement and how they are entered into.

A futures contract is quite similar to a forward contract but is standardized and exchangetraded. The primary ways in which forwards and futures differ are that futures trade in a liquid secondary market, are subject to greater regulation, and trade in markets with more disclosure (transparency). Futures are backed by a central clearinghouse and require daily cash settlement of gains and losses, so that counterparty credit risk is minimized.

Types of Futures

The two basic types of futures are commodity futures and financial futures. Examples of commodities traded in commodity futures markets are agricultural products, metals, energy products, and forest products. An example of a financial future that is traded is a futures contract on debt securities (interest rate future).

Commodity futures were the earliest futures contracts to be traded. Commodities are items that are essentially raw materials for another company.