Question

What is a futures contract? Why are futures contracts considered standardised?

Hint:

Standardisation in futures contracts ensures uniformity, making them easily tradable and reducing uncertainty for market participants.

Answer 1

Futures Contract: A futures contract is a legally binding agreement between two parties to exchange a specified quantity of an asset (like commodities, stocks, or currencies) at a set price on a future date. These contracts are traded on organized exchanges and serve purposes of hedging or speculation. Reasons for Futures Contract Standardization: Futures contracts are standardized due to fixed and uniform terms established by the exchange, which include:

Contract Size: The volume of the underlying asset per contract is fixed.
Quality Specifications: The grade or quality of the underlying asset is predefined.
Delivery Date: The expiration date or month for contract expiry and settlement is predetermined.
Price Quotation: The method for pricing and minimum price movements (tick size) are established.
Trading Hours and Procedures: Uniform trading rules and mechanisms govern all contracts.
Standardization enhances liquidity, trading simplicity, and market transparency and fairness by enabling easy buying and selling of contracts without the need for individual term negotiation.