Underwriting Traders of Financial Futures

Abstract

A futures contract is an agreement to trade an asset at a specific time in the future, at a specific price. Traditionally, the asset involved would be a commodity such as corn, gold, etc. or a financial asset such as a bond or stock. Recently, futures markets have developed for economic variables such as interest rates, freight shipping rates, and currency exchange rates. At the time the contract is made, the buyer and seller agree on the future date of the trade, called the maturity date of the futures contract, and the price of the asset to be traded called the futures price. A forward contract is identical to a futures contract, except in the way the difference between the market price of the asset on the date of the trade and the futures price is handled. Forward contracts require that the difference be made up in cash to the gaining party at the time the trade takes place. Futures contracts require that changes in the futures price be paid in cash as they occur. That is, futures contracts are distinguished from forward contracts by daily resettlement of margin variations. This is called “marking to the market”. [It is interesting that until recent work by Cox et al. (1981) and others (French, 1983; Jarrow and Oldfield, 1981; and Richard and Sundaresan, 1981), most researchers in finance ignored this difference.]