You might have heard the terms speculation, hedging, spot, future etc let me elaborate those terms in my language as per my understanding.
Speculation is about profit making while hedging is protecting one’s profit by minimizing losses and hence is a defensive strategy.
Future market (Price) differs from spot market (Price) because in future market the contracts are traded for future delivery of the particular commodity. The difference between the spot price and the current contract price is called the "basis." The basis equals the cash price minus the futures price.
The future price of any commodity depends on the underlying asset, if the price of underlying asset increases the future price is bound to price.
When one wants to hedge he has two options either “Going Short” or “Going Long”
“Going Short” is opted when it is believed that the prices of the underlying assets are going to come down, so the hedger sells the contract without owing it, later when the price of contract goes down (as per his speculation) he purchases the contract and squares off his/ her position.
“Going Long” is opted when it is believed that the prices of the underlying assets are going to go Up, so the hedger buys the contract, anticipating that the contract prices will go up. When price goes up the Hedger sell the contract, book his profit and square off his/ her position.
Let’s see how it work Say suppose I have to pay 100 thousand USD to my supplier 6 months down the line but I’m not very sure that what will be the dollar price at that point of time. If the dollar / rupee is 47 then my outflow will be 4700 thousand rupees but if it is 50 then my outflow will be 5000 thousand rupees means an additional outflow of 300 thousand Indian rupee, now I want to avoid this loss.
For this I will buy dollar future contract today (say quoting at 48 Rupees) and sell the contract 6 months down the line ( say price of the contract quoting somewhere around 50) through this deal I’ll earn a profit of 200 thousand Indian rupees which will help me in minimizing the losses made if I would have not done it.
Now futures for interest rate are also available I believe it is the right time looking at a greater uncertainty in the global economy and the higher movement in interest rate levels in India also.
The contracts will be settled in March, June, September and December. The maximum maturity will be 12 months. Deliverable securities under the futures should mature between 7.5 and 15 years with minimum outstanding of Rs10,000 crore.
Speculation is about profit making while hedging is protecting one’s profit by minimizing losses and hence is a defensive strategy.
Future market (Price) differs from spot market (Price) because in future market the contracts are traded for future delivery of the particular commodity. The difference between the spot price and the current contract price is called the "basis." The basis equals the cash price minus the futures price.
The future price of any commodity depends on the underlying asset, if the price of underlying asset increases the future price is bound to price.
When one wants to hedge he has two options either “Going Short” or “Going Long”
“Going Short” is opted when it is believed that the prices of the underlying assets are going to come down, so the hedger sells the contract without owing it, later when the price of contract goes down (as per his speculation) he purchases the contract and squares off his/ her position.
“Going Long” is opted when it is believed that the prices of the underlying assets are going to go Up, so the hedger buys the contract, anticipating that the contract prices will go up. When price goes up the Hedger sell the contract, book his profit and square off his/ her position.
Let’s see how it work Say suppose I have to pay 100 thousand USD to my supplier 6 months down the line but I’m not very sure that what will be the dollar price at that point of time. If the dollar / rupee is 47 then my outflow will be 4700 thousand rupees but if it is 50 then my outflow will be 5000 thousand rupees means an additional outflow of 300 thousand Indian rupee, now I want to avoid this loss.
For this I will buy dollar future contract today (say quoting at 48 Rupees) and sell the contract 6 months down the line ( say price of the contract quoting somewhere around 50) through this deal I’ll earn a profit of 200 thousand Indian rupees which will help me in minimizing the losses made if I would have not done it.
Now futures for interest rate are also available I believe it is the right time looking at a greater uncertainty in the global economy and the higher movement in interest rate levels in India also.
The contracts will be settled in March, June, September and December. The maximum maturity will be 12 months. Deliverable securities under the futures should mature between 7.5 and 15 years with minimum outstanding of Rs10,000 crore.
Commercial banks can take trading positions for themselves but not on behalf of their clients. Non-resident Indians, companies, primary dealers and foreigners can also trade in this segment. Foreign investors can trade if they have the underlying security, but not for speculative purposes.
Image source: commoditiesandfuturesguide.com
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