Speculation and hedging and forward and futures trading

Speculation and hedging
Forward trading
Futures trading

1. Speculation

2. Speculation 2 Speculation is the purchase or sale of a commodity at the present price with the object of sale or purchase at some future date at a favourable price . The speculator is normally concerned with profit making from price movements .

3. Speculation 3 He purchases when price is low . He is therefore not a normal or regular trader . The difference in the prices prevailing at two times constitutes his profit .

4. Speculation 4 The essentials of a speculator are: He enters the trade at current prices . The transactions of speculators enter the trade with the sole object of making profit from price movements . Except in a few cases, the physical delivery of produce is neither taken nor given . Speculators are not regular buyers and sellers in the market.

5. Speculation proper 5 It refers to speculation on the part of a person who makes it his profession . Such professional speculators devote their whole time and energy to the collection of information about the future course of price movements . The decisions of the speculator are not hunch decisions. These types of speculation, is beneficial for the economy as a whole and is usually accepted by the society.

6. Illegitimate speculation 6 This is a gamble in business . The speculators adopt such manipulative practices as creating conditions of artificial scarcity in the market and leading to a rise in prices . The main aim of the speculator is to earn a big profit . Such speculation is prohibited by the government in the best interest of the economy.

7. Economic benefits of speculation 7 Speculation dampens price fluctuations - Speculation buy at current price in anticipation of a rise in prices in the future which results in pushing up the current prices . This encourages production and discourages consumption . Other speculators, who sell in the present period in the expectation of a fall in future prices , bring about a fall in the current prices . This encourages consumption and discourages production .

8. Economic benefits of speculation 8 The price differentials in different markets are bridged to some extent. Speculation helps in the adjustment of the supply of, and demand for, commodities at normal prices .

9. Hedging

10. Hedging 10 Hedging is a trading technique of transferring the price risk . It protects traders from extreme crash in prices . Hedging is defined as “the practice of buying or selling futures to offset an equal or opposite position in the cash market and thus avoid the risk of uncertain changes in prices ”.

11. Hedging 11 Hedging refers to the purchase or sale of a commodity in a futures market accompanied by a sale or a purchase in the cash market . Each sale is entered into with an equivalent purchase of the commodity .

12. Hedging - Assumptions 12 The future and cash commodity prices move up and down together , i.e., the basis of prices changes remains unchanged . The mechanics of hedging includes the making of simultaneous transactions , but of opposite nature in the futures and cash markets.

13. Hedging - Benefits 13 It protects the hedger from sustaining loss and enables him to earn his normal trade profit . Hedging enables him to keep the trade margins at a lower level because there is no risk . Hedging facilitates the financing of inventories of stored commodities to the maximum possible extent.

14. Hedging 14 Purchases and sales in the cash as well as in futures markets are made to protect oneself against excessive price fluctuations . The activities of buying and selling are always opposed to each other . It is obligatory to buy and sell the goods in equal quantities in the two markets . The commodities are not stored by traders . Speculation Purchases and sales in the cash as well as in futures markets are made with the objective of making profit . The activities of buying and selling are not necessarily opposed to each other . It is not necessary that the two types of transactions should be of equal quantity . The speculator purchases goods and sells them when prices rise as per his expectations .

15. Forward trading

16. Forward trading 16 Trading in which two parties trade in the underlying asset at an agreed price at a certain time in future .

17. Futures trading

18. Futures trading 18 An agreement between parties to buy or sell the underlying financial asset at a specified rate and time in future . Futures trading is an agreement between a buyer and seller obligating the seller to deliver a specified asset of specified quality and quantity to the buyer on a specified date at a specified place and the buyer in turn is obligating to pay to the seller a pre-negotiated price in exchange of the delivery .

19. Futures trading 19 Futures trading includes both hedging and speculation . But since hedging is its underlying principle, it is also known as hedge-trading . Future markets are therefore known as “ hedge” markets . Futures trading thus performs two important functions viz., price discovery and hedging of price risk in a commodity .

20. Nature of Commodities for Futures trading 20 Commodities should be in plentiful supply . If a commodity is in short supply , a few traders may corner the whole supply and charge any price they like to the buyers. The commodity must have a minimum degree of perishability , i.e., it must be storable for futures delivery .

21. Nature of Commodities for Futures trading 21 The commodity should be homogeneous and capable of being graded so that its future deliveries may be made without problems regarding quality . The commodity should have a large demand from a number of independent consumers so that a single buyer may not be in a position to impose his terms for purchases.

22. Nature of Commodities for Futures trading 22 The supply of the commodity should not be controlled by a few large firms . It should be available with a large number of suppliers. The price of the commodity should be liable to fluctuations over a wide range. There should be free flow of the commodity to and from the market without any outside interference/control .

23. 23 Basis for Comparison Forward Trading Futures Trading Meaning Forward Trading is an agreement between parties to buy and sell the underlying asset at a specified date and agreed rate in future. A Trading in which the parties agree to exchange the asset for cash at a fixed price and at a future specified date, is known as future contract. What is it? It is a tailor made contract. It is a standardized contract. Traded on Over the counter, i.e. there is no secondary market. Organized stock exchange. Settlement On maturity date. On a daily basis. Risk High Low Default As they are private agreement, the chances of default are relatively high. No such probability.

24. 24 Basis for Comparison Forward Trading Futures Trading Size of contract Depends on the contract terms. Fixed Collateral Not required Initial margin required. Maturity As per the terms of contract. Predetermined date Regulation Self regulated By stock exchange Liquidity Low High

25. THANK YOU! Dr.M.Sathaiah , Assistant Professor ( Agrl.Economics ), CAT,Theni