Investments, tenth edition

Value in Next Period as 

Function of Stock Price

Action Today (time 0)

dS

0

 5 $95

uS

0

 5 $110

Buy .4656 shares at price S

0

 5 $100

$44.232

$51.216

Write 1 call at price C

0

      0

  2

6.984

TOTAL

$44.232

$44.232

bod61671_ch21_722-769.indd   769

bod61671_ch21_722-769.indd   769

7/27/13   1:45 AM

7/27/13   1:45 AM

Final PDF to printer

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22 

   FUTURES AND FORWARD  

contracts are like 

options in that they specify purchase or sale 

of some underlying security at some future 

date. The key difference is that the holder 

of an option is not compelled to buy or sell, 

and will not do so if the trade is unprofitable. 

A futures or forward contract, however, car-

ries the obligation to go through with the 

agreed-upon transaction. 

 A forward contract is not an investment 

in the strict sense that funds are paid for an 

asset. It is only a commitment today to transact 

in the future. Forward arrangements are part 

of our study of investments, however, because 

they offer powerful means to hedge other 

investments and generally modify portfolio 

characteristics. 

 Forward markets for future delivery of 

various commodities go back at least to 

ancient Greece. Organized  

futures markets,

though, are a relatively modern develop-

ment, dating only to the 19th century. Futures 

markets replace informal forward contracts 

with highly standardized, exchange-traded 

securities. 

 While futures markets have their roots in 

agricultural products and commodities, the 

markets today are dominated by trading in 

financial futures such as those on stock indexes, 

interest-rate-dependent securities such as gov-

ernment bonds, and foreign exchange. The 

markets themselves also have changed, with 

trading today largely taking place in electronic 

markets. 

 This chapter describes the workings of 

futures markets and the mechanics of trading 

in these markets. We show how futures con-

tracts are useful investment vehicles for both 

hedgers and speculators and how the futures 

price relates to the spot price of an asset. We 

also show how futures can be used in several 

risk-management applications. This chapter 

deals with general principles of future mar-

kets. Chapter 23 describes specific futures 

markets in greater detail.  

 CHAPTER TWENTY-TWO