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An Agreement to Buy or Sell at a Specific Date in the Future at a Predetermined Price Quizlet
Posted by on Wednesday, February 15th, 2023 at 3:52 am
Understanding an Agreement to Buy or Sell at a Specific Date in the Future at a Predetermined Price
In the world of finance, an agreement to buy or sell at a specific date in the future at a predetermined price is commonly referred to as a “futures contract”. This is a legally binding agreement between two parties that obligates each of them to fulfill their obligations at the pre-determined time and price.
Futures contracts are primarily used by traders and investors to mitigate the risks associated with price fluctuations in commodity markets, such as oil or gold. They also play a critical role in hedging strategies for businesses that rely on raw materials to manufacture their products.
Here’s a quick overview of how futures contracts work:
First, a buyer and seller agree on a specific commodity, quantity, price, and delivery date. For example, the buyer may agree to purchase 1,000 barrels of crude oil at $75 per barrel, with delivery to occur in six months.
Once the agreement is made, both parties are locked into their respective obligations. The buyer is obligated to take delivery of the oil, and the seller is obligated to deliver it at the agreed-upon price.
The buyer and seller can settle the contract in a few different ways. One option is for the buyer to take physical delivery of the commodity and pay the pre-determined price. Another option is for the seller to pay the difference between the pre-determined price and the current market price to the buyer.
Futures contracts are traded on organized exchanges, such as the Chicago Mercantile Exchange (CME) or the New York Mercantile Exchange (NYMEX), where standardized contracts are bought and sold by traders and investors.
In addition to mitigating price risk, futures contracts also provide liquidity and price discovery for commodity markets. By allowing buyers and sellers to agree on a future price for a particular commodity, the market can more accurately reflect supply and demand dynamics.
In conclusion, futures contracts provide a valuable tool for traders, investors, and businesses to manage risk and participate in commodity markets. While the concept may seem complex, understanding the basics of futures contracts is essential for anyone involved in the world of finance.
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