Speculation and hedging Forward trading Futures trading

2. 2
• Speculation is the purchase or sale of a
commodity at the present price with the
object of sale or purchase at some future
date at a favourable price.
• The speculator is normally concerned with
profit making from price movements.

3. 3
• He purchases when price is low.
• He is therefore not a normal or regular trader.
• The difference in the prices prevailing at two
times constitutes his profit.

4. 4
The essentials of a speculator are:
• He enters the trade at current prices.
• The transactions of speculators enter the trade
with the sole object of making profit from price
movements.
• Except in a few cases, the physical delivery of
produce is neither taken nor given.
• Speculators are not regular buyers and sellers
in the market.

5. 5
• It refers to speculation on the part of a person who
makes it his profession.
• Such professional speculators devote their whole
time and energy to the collection of information
about the future course of price movements.
• The decisions of the speculator are not hunch
decisions.
• These types of speculation, is beneficial for the
economy as a whole and is usually accepted by the
society.

6. 6
• This is a gamble in business.
• The speculators adopt such manipulative
practices as creating conditions of artificial
scarcity in the market and leading to a rise in
prices.
• The main aim of the speculator is to earn a big
profit.
• Such speculation is prohibited by the
government in the best interest of the economy.

7. 7
• Speculation dampens price fluctuations -
Speculation buy at current price in anticipation
of a rise in prices in the future which results in
pushing up the current prices. This
encourages production and discourages
consumption.
• Other speculators, who sell in the present
period in the expectation of a fall in future
prices, bring about a fall in the current prices.
This encourages consumption and
discourages production .

8. 8
• The price differentials in different markets
are bridged to some extent.
• Speculation helps in the adjustment of the
supply of, and demand for, commodities at
normal prices.

10. 10
• Hedging is a trading technique of
transferring the price risk.
• It protects traders from extreme crash in
prices.
• Hedging is defined as “the practice of buying
or selling futures to offset an equal or
opposite position in the cash market and
thus avoid the risk of uncertain changes in
prices”.

11. 11
• Hedging refers to the purchase or sale of a
commodity in a futures market accompanied
by a sale or a purchase in the cash market.
• Each sale is entered into with an equivalent
purchase of the commodity.

12. 12
1. The future and cash commodity prices
move up and down together, i.e., the basis
of prices changes remains unchanged.
2. The mechanics of hedging includes the
making of simultaneous transactions, but
of opposite nature in the futures and cash
markets.

13. 13
• It protects the hedger from sustaining loss
and enables him to earn his normal trade
profit.
• Hedging enables him to keep the trade
margins at a lower level because there is
no risk.
• Hedging facilitates the financing of
inventories of stored commodities to the
maximum possible extent.

14. 14
• Purchases and sales in the cash as well as in
futures markets are made to protect oneself
against excessive price fluctuations.
• The activities of buying and selling are always
opposed to each other.
• It is obligatory to buy and sell the goods in
equal quantities in the two markets.
• The commodities are not stored by traders.
• Purchases and sales in the cash as well as in
futures markets are made with the objective
of making profit.
• The activities of buying and selling are not
necessarily opposed to each other.
• It is not necessary that the two types of
transactions should be of equal quantity.
• The speculator purchases goods and sells
them when prices rise as per his
expectations.

16. 16
• Trading in which two parties trade in the
underlying asset at an agreed price at a
certain time in future.

18. 18
• An agreement between parties to buy or sell
the underlying financial asset at a specified rate
and time in future.
• Futures trading is an agreement between a buyer
and seller obligating the seller to deliver a
specified asset of specified quality and
quantity to the buyer on a specified date at a
specified place and the buyer in turn is
obligating to pay to the seller a pre-negotiated
price in exchange of the delivery.

19. 19
• Futures trading includes both hedging and
speculation. But since hedging is its
underlying principle, it is also known as hedge-
trading.
• Future markets are therefore known as
“hedge” markets.
• Futures trading thus performs two important
functions viz., price discovery and hedging
of price risk in a commodity.

20. 20
• Commodities should be in plentiful supply. If
a commodity is in short supply, a few
traders may corner the whole supply and
charge any price they like to the buyers.
• The commodity must have a minimum degree
of perishability, i.e., it must be storable for
futures delivery.

21. 21
• The commodity should be homogeneous
and capable of being graded so that its future
deliveries may be made without problems
regarding quality.
• The commodity should have a large demand
from a number of independent consumers
so that a single buyer may not be in a position
to impose his terms for purchases.

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• The supply of the commodity should not be
controlled by a few large firms. It should be
available with a large number of suppliers.
• The price of the commodity should be liable
to fluctuations over a wide range.
• There should be free flow of the commodity
to and from the market without any outside
interference/control.

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Basis for
Comparison
Forward Trading Futures Trading
Meaning Forward Trading is an agreement
between parties to buy and sell the
underlying asset at a specified date
and agreed rate in future.
A Trading in which the parties agree to
exchange the asset for cash at a fixed
price and at a future specified date, is
known as future contract.
What is it? It is a tailor made contract. It is a standardized contract.
Traded on Over the counter, i.e. there is no
secondary market.
Organized stock exchange.
Settlement On maturity date. On a daily basis.
Risk High Low
Default As they are private agreement, the
chances of default are relatively
high.
No such probability.

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Basis for
Comparison
Forward Trading Futures Trading
Size of contract Depends on the contract terms. Fixed
Collateral Not required Initial margin required.
Maturity As per the terms of contract. Predetermined date
Regulation Self regulated By stock exchange
Liquidity Low High