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DEFINITION QUESTIONS ABOUT FUTURES MARKETS: 1- Why are relatively few futures contracts settled by delivery? 2-...

DEFINITION QUESTIONS ABOUT FUTURES MARKETS:

1- Why are relatively few futures contracts settled by delivery?

2- Why is marking-to-market each day in cash such a powerful risk management tool?

3- What are the economic functions of futures markets?

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Answer #1

1) Most of the futures contracts are now settled by cash. The reason behind this type of settlement is cost associated with physical delivery. Also the regulatory authority ensures total transparency in the cash settlement process. Cash settlement is more convenient then physical settlement.

2) M2M is a daily cash adjustment because of which the exchange board reduces the risk of defaulting by counterparty. As long a trader holds the contract, the exchange board by virtue of the M2M ensures both the parties are fair and square on a daily basis. That is why MTM each day is powerful risk management tool.

3) Four major economic fnctions: a. Pricing b. Organizing markets c. Speculating d. Hedging. Also Futures market is structured to overcome some critical risks like 1) Liquidity risk 2) regulatory risks 3) defaulting risks etc.

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