Introduction
In finance terminology, the future is a standardized contract where the sale and purchase of physical or financial commodities take place for future delivery by the futures exchange to be used for the particular commodity. Future contracts were developed in the year 1865 by the Chicago Board of Trade. The market where future contracts take place is called a future market.
Thus it can be said that the future market is a central financial exchange for standardized future contracts and where parties can trade on these future standardized contracts. A futures contract allows a trader to undertake a contract to accept or make delivery of a commodity or some kind of financial asset in the future on a known date under specified conditions.
There are two types of institutions which are involved in future contract trading. These institutions are:
- Exchanges: These are nonprofit or profit organizations which deals in standardized future contract and exchange of physical commodities, foreign currency, and financial products take place through these exchanges.
- Clearing House: This is an agency which deals in various exchange procedures and also helps in settling various trade transactions and also helps in regulating the delivery of goods. This agency guarantees that all future contracts will be fulfilled and all the parties are under obligation to fulfil all future contracts.
Centralized exchanges help in risk reduction so the buyers and sellers are not much worried about risk reduction but they focus their attention on price movements. Thus future contract allows the trader of goods to make delivery of the commodity or any financial instrument in future on a known date, under specific terms and conditions and for a price agreed on the day of the contract.
There is various type of future contracts which are being traded in the future market. These are depicted in the following diagram:
Thus, it can be said that all these future contracts are standardized instruments, and they specify the delivery of a specific quantity of a specific commodity on a specific date, which fulfills all the requirements of quality standards.
Meaning Future Market
A future market is a centralized financial exchange for trading on standardized future contracts, and this a contract which deals in buying a specific quantity of commodities or financial assets at a specified price and specified date and time in the near future.
According to The New Palgrave (Dictionary of Economics Newberry 2008), the future market provides partial income risk insurance to producers whose output is risky but serves as a very effective insurance to stockholders at a very low cost.
Role of Future Markets
The future market is highly active and occupies a central position in the global market. It also serves as a good source in providing vital market information to various interested parties and also acts as a price indicator for the market. Thus, the future market helps in price discovery.
Future markets act as an important economic tool in the determination of prices based on today’s and tomorrow’s supply and demand in the near future. Various factors like weather, war, and debt all have major effects on the supply and demand of the commodity which ultimately affects the future prices of the commodity.
The impact on prices due to changes in demand and supply patterns is also known as price discovery. Thus, future collects all the information about demand and supply pattern and present all the information to various traders in a very transparent manner. It can be said that the future market helps in price discovery.
Future markets also provide a place for people to reduce risk because when purchases are being made by traders, the prices are being pre-set in advance, which helps the traders determine how much they will buy and sell in the near future. Thus, the future market also helps in risk reduction.
The future market also helps businesses to protect against price fluctuations and also provides a protective cover to buyers from future increase in prices and to seller from future price fall. The future market also helps in price forecasting and also provides a trading platform and global market for consumer manufacturers across all over the world.
The future market also facilitates competitive pricing and also keeps a balance in the prices of the commodities that are to be traded in the future. Thus it can be concluded that the future market helps in price discovery, risk reduction and price stability in the market.
The future market also helps in meeting the needs of the following three groups of users:
- (a). Those who want to discover information about future prices of commodities.
- (b). Those who want to speculate in the market.
- (c). Those who want to hedge in the market.
Thus it can be concluded that the main social function of the future market is price discovery, hedging, and to maintain price stability in the market.
Uncertainty in Future Market
Various types of uncertainties prevail, which affect the operation of the future market. Technologies are changing now and then and vast changes in technology have forced marketers to have a clear picture of the uncertainties and their impact on the future market. It can be said that uncertainties are things that are not known and, if known, are also in an imprecise manner.
Uncertainty, in simple words, means the ability to forecast future events. People are not in a position where they can predict how a recession will affect them and to which extent they will be affected by this recession. They are not aware of when the recession phase will start, when it will end and how companies will also be affected by the recession phase. All these questions are being left unscathed because of a high degree of uncertainty that prevails in the market.
In economics, uncertainty means that the future outlook for the economy is unpredictable. This type of uncertainty is also known as economic uncertainty. It means that the economy will be in a negative phase and there are chances that negative events will occur in the economy in future.
When economic uncertainty prevails in the economy, then there are chances that inflation will be more volatile and the inflation rate will reach a very high rate. This is also known as inflation uncertainty.
When economic uncertainty prevails in the economy, then people have the fear of losing their job and they will be unemployed in the near future. The exchange rate will also see a rapid fluctuation in the near future. The rapid devaluation of currency will be there in the economy.
Due to uncertainty in the future market investors also attempt to shift their currency from unstable sources to stable sources. If investors feel that war war-like situation can occur in the future then due to this threat the currency of a country will be sold, and the currencies from countries without the threat of war are being purchased. Selling and buying of currency from one country to another is known as devaluation in future markets.
The rising level of uncertainty also creates a situation of confusion among the well-informed investors also. The stockholders also due to uncertainty feel their funds are unsafe and they move their funds to other sources like buying precious metals, government bonds and other money market instruments.
No one can give a valuable judgment on what will happen in the future, it can be a worse situation or a better situation than expected. This is all because the market is uncertain.
There are various factors responsible which lead to the emergence of uncertain situations in the future market, which are being explained with the help of the following diagram.
Factors of Uncertainty
(1) Insufficient Knowledge:
Facts which are not known or that cannot be estimated in the near future, it becomes very difficult to collect valuable information about such facts. So, insufficient knowledge of facts and figures gives rise to uncertainty.
(2) Lack of Definition:
It is very difficult to define what kind of situation will occur in the near future. The situation can be worse or healthy it becomes a tedious task to define these situations in the near future.
(3) Unknown Known:
This statement means that things that are known are not known. For example, Budget, Changes in technology falls into this category. Companies are aware that technology will change in the near future, but what kind of technology will emerge that is unknown.
(4) Unknown Unknown:
This means that things that are not known cannot be predicted in the near future. For example, Disasters due to floods and bad weather conditions come under this category. It is an unknown fact that a flood can occur, when it will occur and to what extent it will affect the business operation all is unknown.
Thus, these were the various kinds of factors that lead to uncertainties in the future market. The consequences of uncertainty that leads to the emergence of risk in the future market, and due to various kind of risk so many good investment opportunities are being lost by investors.
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