Introduction to Forward and Futures * Forward Contract: it is an agreement to buy or sell an asset at a certain future time for a certain price. A forward contract is traded in the over-the-counter market, usually between two financial institutions or between a financial institution and one of its clients. * Collateralization in OTC Markets: two parties enter into a collateralization agreement where they value the contract each day using a pre-agreed valuation methodology. Then it works like Margin Account. * Futures Contracts: Like a forward contract, a futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future for a certain price. Unlike forward contracts, futures contracts are normally traded on an exchange. Closing out a position means entering into the opposite type of trade from the original one. * Contract Size: it is specified by the Exchange. If the contract size is too large, many investors who wish to take relatively small speculative positions will be unable to use the exchange. If the contract size is too small, trading may be expensive as there is a cost associated with each contract traded. * Price limits & Position limits: daily price movement limits (limit down and limit up) are specified by the exchange. Normally, trading ceases for the day once the contract is limit up or limit down. The purpose of daily price limits is to prevent large price movements from occurring because of speculative excesses. Position limits are the maximum number of contracts that a speculator may hold. The purpose of the limits is to prevent speculators from exercising undue influence on the market. * As the delivery period for a futures contract is approached, the futures price converges to the spot price of the underlying asset. Otherwise, there will be arbitrage opportunity. *