Question

_____10. What is a futures contract? How does that compare against a forward? What is a Call Option? How does it compare against a Put Option? (10 points)

Answer 1

Futures contract is a contract to buy or sell a particular commodity or security at a predetermined price at a particular time in future .It is a financial derivative contract which allows investor to speculate and also to hedge the change in the price movement of commodity or security to help prevent loss .

If we compare futures with forward then we can say both are agreement to buy or sell security or commodity at a future date but Forward contract is an over the counter arrangement while futures are traded on exchange.Forward contract are settled only at the end of contract while Futures are settled on daily basis.Also Futures are standardized in terms of quantity and maturity date but forwards are privately agreed contracts .

A call option is also a financial derivative which gives investor the right but not the obligation to buy an underlying asset at a fixed price called exercise price at a future date .Investor is required to pay an upfront premium to enter this contract .In other words ,we can say that if it seems beneficial to investor at the maturity to exercise the option then he can exercise otherwise he is not bound to exercise the option.

While Put option gives investor the right but not the obligation to sell an underlying asset at a Fixed price called exercise price .It means if at the time of maturity price falls below exercise price then investor can sell the asset at exercise price but if price rises above exercise price then he can choose not to exercise option and sell the asset at higher price .Premium is required to be paid in this option also.