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The futures markets · lesson 2 of 20

Standardisation and the exchange

Futures are traded on an exchange and are standardised. For each contract the exchange sets the quantity, the quality of the underlying, the expiry dates and the settlement method. The parties negotiate only the price.

Standardisation makes contracts interchangeable. Whoever has bought a contract can get out by selling an identical contract, without having to find the original counterparty again.

Non-standardised contracts, negotiated directly between two parties, are called forwards. They are more flexible but less liquid, and they carry the risk that the counterparty fails to perform.

Questions

1. What do the parties to a future negotiate?

Only the price

Everything else is set by the exchange.

2. What is the advantage of standardisation?

You can get out by selling an identical contract

The contracts are interchangeable and therefore liquid.

3. What is a forward?

A non-standardised contract for future delivery, negotiated between two parties

It is more flexible but carries counterparty risk.

Next lesson: The clearing house

Continue from lesson 4

The futures markets: an online course in 20 short lessons with quizzes and a final certificate, on Unicorn Academy.

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