The financial markets are susceptible to high degree of volatility.Hence to spread the risk a number of financial instruments like futures contract,forward contract and options are introduced in the financial market.

These instruments are called DERIVATIVES since they derive their value from the value of the underlying assets like bonds,equity,currency,indices and commodities.

So now to acquaint with futures contract:

It is a legally binding agreement between two parties to buy or sell an asset at a certain time in the future for a certain price.They are standardized according to the quality,quantity,delivery time and location and they are traded on an exchange. F For example a corn future may be quoted as1000bushel of NO.2 yellow grade to be delivered in December trading month at Chicago Board Of Trade at price of "x".

Normally futures contracts are entered either by Hedgers who would like to cover the risk in the fall in value of the asset or by SPECULATORS who take advantage of the price fluctuation and book the profit without holding the assets physically.

The buyer of the future contract is benefited if the price of the asset increases and ofcourse he losses if the value falls .This is called taking a LONG POSITION.we have already seen that physical holding of the asset is rare and hence to CLOSE OUT the transaction an opposite transaction ie sale contract is taken.Taking a sale contract without possessing the asset is called Taking a SHORT POSITION.

When actual delivery of asset is rare the players donot need huge outlay of funds.The market operates effectively on keeping the MARGIN for these highly geared financial instruments.

How does this system works?

To minimize the credit risk initial margin is paid both by the buyer and the seller of the contract.This margin represents the loss that may occur on a particular trading day on that asset as estimated basing on the historical price changes.

The market is highly liquid and the contracts are MARKED TO THE MARKET ie marked to the daily changes in the value of the asset.So any fluctuation will need either additional margin or if the players choose they may close out the transaction by taking a long position or a short position.

An example is given for keeping the margin and closing out the transaction for better understanding.

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