| THE     FUTURES         MARKET | 
| INTRODUCTION What we 
    know as the futures market of today came from some 
    humble beginnings. Trading in futures originated in Japan during 
    the 18th century and was primarily used for the trading of rice and 
    silk. It wasn't until the 1850s that the U.S. started using futures 
    markets to buy and sell commodities such as cotton, corn and 
    wheat.  A futures 
    contract is a type of derivative instrument, or financial 
    contract, in which two parties agree to transact a set of financial 
    instruments or physical commodities for future delivery at a 
    particular price. If you buy a futures contract, you are basically 
    agreeing to buy something, for a set price, that is not deliverable 
    until a future date. But participating in the futures market does not 
    necessarily mean that you will be responsible for receiving or 
    delivering large inventories of physical commodities. Traders in the 
    futures market primarily enter into futures contracts to hedge risk or 
    speculate rather than exchange physical goods. The cash (spot) 
    market is where producers exchange physical goods. Futures are 
    used as financial instruments which to eventually tend to parralell 
    the price movement of the underlying cash market.  The consensus 
    in the investment world is that the futures market is 
    a major financial hub, providing an outlet for intense competition 
    among buyers and sellers and, more importantly, providing a center 
    to manage price risks. The futures market is extremely liquid, risky, 
    and complex by nature, but it can be understood if we break down 
    how it functions.  While futures 
    are not for the risk-averse, they are useful for a wide 
    range of people. A common denominator among all futures 
    contracts, is the need for hedging the underlying commodity.  | 
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| HISTORY Before the 
    North American futures market originated some 150 
    years ago, farmers would grow their crops and then bring them to 
    market in the hope of selling their inventory. But without any 
    indication of demand, supply often exceeded what was needed, and 
    unpurchased crops were left to rot in the streets. Conversely, when 
    a given commodity, such as grain, was out of season, the goods 
    made from it became very expensive because the crop was no 
    longer available.  In the mid-19th 
    century, central grain markets were established and 
    a central marketplace was created for farmers to bring their 
    commodities and sell them either for immediate delivery (spot 
    trading) or for forward delivery. The forward delivery contracts were 
    the forerunners to today's futures contracts. In fact, this concept 
    saved many a farmer the loss of crops and profits and helped 
    stabilize supply and prices in the off-season. An important 
    distinction between forward contracts and futures contracts is 
    contract spefication. Specifications for all futures contracts for a 
    particular commodity are the same, except for price. Forward 
    contracts could have varying specifications, such as size, quality, 
    and delivery date.  As the agriculture 
    commodities dominated the futures markets for 
    over 100 years, financial contracts, such as foreign currencies, 
    treasuries, and stock indices were introduced in the 1970's and 
    1980's, and have dominated the futures industry ever since. | 
| HOW IT WORKS The futures 
    market is a centralized marketplace for buyers and 
    sellers from around the world who meet and enter into futures 
    contracts. Pricing can be based on an open cry system, or bids and 
    offers can be matched electronically. The futures contract will state 
    the price that will be paid and the date of delivery. But don't worry, 
    as we mentioned earlier, almost all futures contracts end without 
    the actual physical delivery of the commodity  A futures 
    contract is an agreement between two parties: a short 
    position, the party who agrees to deliver a commodity, and a long 
    position, the party who agrees to receive a commodity.  In every 
    futures contract, everything is specified. The quantity and 
    quality of the commodity, the specific price per unit, and the date 
    and method of delivery. The price of a futures contract is 
    represented by the agreed-upon price of the underlying commodity 
    or financial instrument that will be delivered in the future.  Profit And 
    Loss - Open Trade Equity  The profits 
    and losses of a futures depend on the daily movements 
    of the market for that contract and is calculated on a daily basis. For 
    example, say the futures contracts for wheat increases 10 cents per 
    bushel the day after a trade is made. (Each cent change is equal to 
    $50.00).  On the day 
    the change occurs, the seller's account is debited $500 
    (10 cent x $50), and the buyers account is credited $500. As the 
    market moves every day, these kinds of adjustments are made 
    accordingly. Unlike the stock market, futures positions are settled 
    on a daily basis, which means that gains and losses from a day's 
    trading are deducted or credited to a person's account each day. In 
    the stock market, the capital gains or losses from movements in 
    price aren't realized until the investor decides to sell the stock or 
    cover his or her short position.  As the accounts 
    of the parties in futures contracts are adjusted 
    every day, most transactions in the futures market are settled in 
    cash, and the actual physical commodity is bought or sold in the 
    cash market. Prices in the cash and futures market tend to move 
    parallel to one another, and when a futures contract expires, the 
    prices merge into one price. So on the date either party decides to 
    close out their futures position, the contract will be settled.  A futures 
    contract is really more like a financial position. You can 
    see that the two parties in the wheat futures contract discussed 
    above could be speculators or hedgers. If a speculator, the profit or 
    loss is treated as a short-term capital gain. If a hedger, the gain or 
    loss would offset the change in value of the underlying physical 
    commodity. | 
| THE PLAYERS Hedgers  Farmers, 
    manufacturers, importers and exporters can all be 
    hedgers. A hedger buys or sells in the futures market to secure the 
    future price of a commodity intended to be sold at a later date in the 
    cash market. This helps protect against price risks.  The holders 
    of the long position in futures contracts (the buyers of 
    the commodity), are trying to secure as low a price as possible. The 
    short holders of the contract (the sellers of the commodity) will want 
    to secure as high a price as possible. The futures contract, 
    however, provides a definite price certainty for both parties, which 
    reduces the risks associated with price volatility. Hedging by means 
    of futures contracts can also be used as a means to lock in an 
    acceptable price margin between the cost of the raw material and 
    the retail cost of the final product sold.  Speculators  Other market 
    participants, however, do not aim to minimize risk but 
    rather to benefit from the inherently risky nature of the futures 
    market. These are the speculators, and they aim to profit from the 
    very price change that hedgers are protecting themselves against. 
    Hedgers want to minimize their risk no matter what they're investing 
    in, while speculators want to increase their risk and therefore 
    maximize their profits. The speculator is vitally important as they 
    help provide the liquidity that the hedger needs.  In the futures 
    market, a speculator buying a contract low in order to 
    sell high in the future might be buying that contract from a hedger 
    selling a contract low in anticipation of declining prices in the future.  Unlike the 
    hedger, the speculator does not actually seek to own the 
    commodity in question. Rather, he or she will enter the market 
    seeking profits by offsetting rising and declining prices through the 
    buying and selling of contracts. | 
| REGULATION The United 
    States' futures market is regulated by the Commodity 
    Futures Trading Commission (CFTC), an independent agency of 
    the U.S. government. The market is also subject to regulation by 
    the National Futures Association (NFA), a self-regulatory body 
    authorized by the U.S. Congress and subject to CFTC supervision.  A broker 
    and/or firm must be registered with the CFTC in order to 
    issue or buy or sell futures contracts. Futures brokers must also be 
    registered with the NFA and the CFTC in order to conduct business. 
    The CFTC has the power to seek criminal prosecution through the 
    Department of Justice in cases of illegal activity, while violations 
    against the NFA's business ethics and code of conduct can 
    permanently bar a company or a person from dealing on the futures 
    exchange. It is imperative for investors wanting to enter the futures 
    market to understand these regulations and make sure that the 
    brokers, traders or companies acting on their behalf are licensed by 
    the CFTC.  In the unfortunate 
    event of conflict or illegal loss, you can look to the 
    NFA for arbitration and appeal to the CFTC for reparations. Know 
    your rights as an investor!  | 
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