Regulated Futures Contract

Regulated Futures Contract Margin Account Marking to Market Qualified Board of Exchange Financial Agreements
A regulated futures contract is a financial agreement that ensures daily settlement of gains or losses through margin accounts, and it must be traded on a qualified exchange following specified rules.
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Definition

A regulated futures contract is a standardized, legally binding agreement to buy or sell a specific quantity of a commodity, stock, currency, or other financial instrument at a predetermined price at a specified future date. The contract implies two key conditions:

  1. Margin Account Adjustments: Parties involved must deposit or withdraw amounts from a margin account based on daily market conditions, following a process known as marking to market.
  2. Exchange Rules: The contracts are traded on, or subject to the regulations of, a qualified board of exchange.

Examples

  • A futures contract on crude oil where the trader commits to buying 1,000 barrels at a future date at a predetermined price.
  • A contract on the S&P 500 index which is settled daily based on the closing price of the index, ensuring any gains or losses are reflected in the margin account.
  • Currency futures contracts where two parties agree to exchange specific amounts of currency at a set future date and rate, with daily settlements adjusting for market fluctuations.

Frequently Asked Questions

Q: What is meant by “marking to market”? A: Marking to market is an accounting practice by which the daily settlement of profits and losses is determined based on the current market values of the involved assets. In futures trading, it involves adjusting the margin accounts daily to reflect gains or losses.

Q: How do regulated futures contracts differ from forward contracts? A: Unlike regulated futures contracts, forward contracts are private agreements between parties that can be customized. Futures contracts, on the other hand, are standardized and traded on exchanges.

Q: What is a margin account? A: A margin account is a brokerage account wherein the broker lends the investor funds to purchase securities and collateralizes the loan with the security itself.

  1. Margin Account: A brokerage account in which the broker lends the investor funds to buy securities.
  2. Mark to the Market (Marking to Market): An accounting method that measures the fair value of accounts that can change over time, like assets and liabilities, typically for settling trades.
  3. Qualified Board of Exchange: An exchange that complies with regulatory requirements to facilitate the trading of standardized, regulated contracts.
  4. Hedging: The practice of making an investment to reduce the risk of adverse price movements in an asset, often using futures contracts.
  5. Derivatives: Financial instruments whose value is dependent on the value of underlying assets such as stocks, bonds, commodities, interest rates, or currencies.

Online References

Suggested Books for Further Studies

  1. “Trading Commodities and Financial Futures: A Step-by-Step Guide to Mastering the Markets” by George Kleinman

    • A comprehensive guide to understanding and trading futures contracts.

  2. “Option Volatility and Pricing: Advanced Trading Strategies and Techniques” by Sheldon Natenberg

    • Provides an in-depth understanding of derivatives including futures and options trading.

  3. “Futures, Options, and Swaps” by Robert W. Kolb and James A. Overdahl

    • An academic textbook that covers the full range of instruments in the derivatives market, including futures.

Fundamentals of Regulated Futures Contracts: Finance Basics Quiz

### What is the main function of a margin account in futures trading? - [ ] To store securities long-term. - [x] To serve as collateral and manage daily settlement of gains and losses. - [ ] To hold only cash deposits. - [ ] None of the above. > **Explanation:** A margin account in futures trading is used to manage daily settlements of gains and losses, reflecting daily market conditions. ### What describes the process of marking to market? - [x] Daily adjusting the margin account balance based on market conditions. - [ ] Holding the assets until maturity. - [ ] Fixing prices regardless of market changes. - [ ] Exchanging physical assets. > **Explanation:** Marking to market involves daily adjustment of the margin account based on current market prices to reflect gains or losses. ### How can regulated futures contracts help in risk management? - [x] By hedging against price movements of assets. - [ ] By guaranteeing profits. - [ ] By eliminating market risk entirely. - [ ] By cancelling existing contracts. > **Explanation:** Regulated futures contracts can be used for hedging to protect against adverse price movements, thus mitigating risk. ### Which entity typically oversees the trading of futures contracts in the United States? - [ ] Federal Reserve - [x] Commodity Futures Trading Commission (CFTC) - [ ] Securities and Exchange Commission (SEC) - [ ] Internal Revenue Service (IRS) > **Explanation:** The Commodity Futures Trading Commission (CFTC) regulates the futures markets in the United States. ### What key characteristic differentiates futures contracts from forward contracts? - [ ] Forward contracts are standardized. - [x] Futures contracts are standardized and traded on exchanges. - [ ] Futures contracts are private agreements. - [ ] Forward contracts require margin accounts. > **Explanation:** Futures contracts are standardized and traded on exchanges, whereas forward contracts are customized, private agreements. ### What is not a typical underlying asset for a futures contract? - [ ] Crude oil - [ ] S&P 500 Index - [ ] Currency exchange rates - [x] Private equity shares > **Explanation:** Futures contracts usually involve commodities, financial indices, and currency rates. They do not typically cover private equity shares. ### Why is daily settlement crucial in futures trading? - [ ] To accumulate interests. - [ ] To delay the risk. - [x] To manage and offset daily gains or losses. - [ ] To avoid taxation. > **Explanation:** Daily settlement through marking to market manages and offsets daily gains or losses, ensuring the margin account reflects current market conditions. ### In what market condition might hedging with futures be especially valuable? - [x] High volatility - [ ] Stable markets - [ ] Consistently dropping markets - [ ] Significant backwardation > **Explanation:** Hedging with futures is particularly valuable in high volatility conditions to protect against significant adverse price movements. ### What aspect ensures that futures contracts are legally binding? - [ ] Custom clauses - [x] Exchange regulations - [ ] Personal agreement - [ ] Verbal commitments > **Explanation:** Exchange regulations standardize and enforce the legality and reliability of futures contracts. ### How does leverage apply to futures trading? - [x] By using borrowed funds to increase trade exposure. - [ ] By owning the asset physically. - [ ] By keeping a 1:1 ratio of asset and capital. - [ ] By minimizing trading frequency. > **Explanation:** Leverage in futures trading involves using borrowed funds to increase trade exposure, which can magnify both gains and losses.

Thank you for deepening your understanding of regulated futures contracts. Keep striving to excel in the fascinating realm of finance and derivatives trading!

Wednesday, August 7, 2024
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