1. FUTURES DEFINITION Futures (forward) contracts are agreements between two agents where one agrees to purchase and the other to sell (deliver) a given amount of a specific commodity at a specific price at a future (prompt) date. Like an order for furniture, house, car, etc. at fixed price.

2. BASIC FEATURES Both parties are "obliged" -> not optional Buy (long) - sell (short) Like options - zero sum - derivative security No money changes hands initially - Margin put up Mark to market daily - money moves between margin accounts Delivery is seldom taken - only 2% (like options) 70% of traders lose money - some win big (Hillary).

3. FUTURES VS. FORWARD CONTRACTS FUTURES CONTRACTS ARE STANDARDIZED sold on exchanges - Chicago Board of Trade (1848) involve clearing house trading in pit - no specialist - different prices FORWARD CONTRACTS ARE NOT STANDARDIZED sold over the phone (over the counter) no clearing house common for currency trading - banks 24 hour market no mark to market - end day settlement allow contingent delivery - sale of house etc.

4. Look at Futures Quotes – www.futuresource.com QUESTION: Which commodities are likely to have futures traded? commodity that can be graded - standardized - widely used - volatile price HOW USED - HELPS BUSINESSES PLAN hedging - farmer - short hedge -grain processor - long hedge speculating - traders virtual company - trade crude against gas to earn change in refiner profit

5. EXAMPLE: Calculating returns on futures -speculator ASSUME: - It is January - July wheat futures sell for 4.84/bushel - Each contract covers 3000 bushels - Margin rate is 15% - Trading commission is $30/roundtrip Buy 5 contracts Figure your investment = 5 x 3000 x 4.84 x.15 + (30 x 5) = 11,040

6. A. Sell your futures in April when price is 4.96 / bushel =.149/4 months or 44.8% annual B.Sell your futures in March when price is 4.75/bushel = -.136/3 months or -54.3% annual

7. Hedging Locks in Profit SIMPLE HEDGING EXAMPLE - CORN Farmer - is a short hedger - hedges risk by selling futures. Kelloggs - is a long hedger - hedges risk by buying futures. TimingFarmerKelloggs nowsell futures 5buy futures-5 latercost to grow -4sell cereal 6 Net Profit 1 1

8. Price Changes Have No Net Impact Suppose corn price is $3 at prompt date. What do the Farmer and Kelloggs do? FarmerKelloggs Sell corn in Iowa 3Buy corn in Michigan-3 Buy back futures -3Sell back futures 3 NET 0 0 What are the respective gains and losses for the Farmer and Kelloggs? FarmerKelloggs Loss on corn sale-2Gain on corn buy 2 Gain on futures 2Loss on futures -2 NET 0 0

9. Futures Gain (Loss) Offsets Asset Loss (Gain) Suppose corn price is $6 at prompt date. What do they do then? FarmerKelloggs Sell corn in Iowa 6Buy corn in Michigan-6 Buy back futures-6Sell back futures 6 NET 0 0 What are the respective gains and losses? FarmerKelloggs Gain on corn sale 1Loss on corn buy-1 Loss on futures-1Gain on futures 1 NET 0 0