Verifying hedge with futures margin mechanics | Finance & Capital Markets | Khan Academy | Summary and Q&A

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March 23, 2011
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Khan Academy
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Verifying hedge with futures margin mechanics | Finance & Capital Markets | Khan Academy

TL;DR

Futures contracts protect sellers and buyers from price volatility, ensuring they can sell or buy at the desired price.

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Questions & Answers

Q: How do futures contracts protect sellers and buyers from price volatility?

Futures contracts use margin mechanics to mark the delivery price up or down daily, ensuring that sellers and buyers can still trade at the desired price, despite market fluctuations.

Q: What happens if the delivery price decreases as the delivery date approaches?

In this scenario, the buyer benefits from a lower delivery price, but the marking to market mechanism requires the buyer to transfer the same amount of money to the seller's margin account, ensuring fairness in the transaction.

Q: What if the delivery price increases close to the delivery date?

If the delivery price goes up, the seller receives a higher price, but they must transfer money to the buyer's margin account to maintain balance. This ensures that the buyer still only pays the agreed-upon price.

Q: How does the marking to market process impact the sellers and buyers economically?

The marking to market process ensures that sellers and buyers receive the economic value they initially intended, regardless of market price fluctuations. Sellers receive additional funds in their margin accounts, compensating for lower delivery prices, while buyers pay less than the increased market price.

Summary & Key Takeaways

  • Futures contracts allow sellers and buyers to avoid price volatility in the market.

  • As the delivery price of the futures contract changes, money is transferred between the buyer's and seller's margin accounts.

  • The marking to market process ensures that sellers and buyers transact at the desired price, regardless of market fluctuations.

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