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Now let’s talk about how many types of derivatives are there. There are mainly 4 modes. Forwards, futures, options and swaps. In today’s blog we are going to discuss about forward and future and the good thing is that forward and future are almost the same. So you have understood one, the other will automatically be understood. So let’s start with what a forward is.
By way of an example and it used to happen exactly during Chanakya’s time as I am going to give you an example – suppose a farmer is ready to sell his potatoes today.
At the rate of ₹ 2 per kg and he wants that yes it would be good if I get ₹ 2 because last year the crop was more of potatoes, so he had to sell potatoes at the rate of Rs.
Due to which he had suffered loss, so now the price of potato is running for ₹ 2 kg, he can send it if he wants, but there is a problem in this, his crop is not ready yet, the crop will be ready, after 2 months now the farmer is worried that Don’t know what will be the price of potatoes after 2 months.
Today it is ₹ 2 but my crop is not ready. In such a situation, if he finds such a buyer who tells him that today we sign the contract that whenever your crop is ready after 2 months, then whatever be the price of potatoes in the market at that time, you will give me your potatoes according to ₹ 2 kg. to sell No matter what the price was at that time, why is it good for the farmer now?
The farmer is afraid that after 2 months, if the price is late, then he will get one and a half rupees, after 2 months, it is good for the farmer. That he should sign the contract today that after 2 months the price of potatoes be one rupee or ₹ 3 he will sell his potatoes for ₹ 2.
So he knows that his minimum viability will come, he is the other who is buying, maybe it is some multinational company that makes chips and 2 years ago when the potato crop was damaged due to rain, then that multinational company Had to buy potatoes for 2.5 ₹ 3 kg
Due to which the cost of making their chips increased. So he also wants to make a contact that if there is more rain this time too, if the crop gets spoiled, then if the potato does not become expensive, then we still contact that we will get potatoes after two months at Rs. win win for
And because this contract is being signed today but in this the delivery condition will be fulfilled after 2 months, that is why it is called forward contract.
Now from this example I hope that the forward contract is cleared now let’s talk about futures. Which you can really trade in the stock market, forward is used for a little over-the-counter or physical trade, so you cannot do forward contracts from the app sitting at home, so it is not that useful but in futures you can really trade can do.
So now what is the futures is simple like you have seen that there is a farmer in the forward and there is a multinational company and they are related to each other, then imagine that which is a multinational company.
He has taken potatoes but is hesitant to give money, so where will the farmer wander from rate to rate and go round the courts, it is risky to recover money from that multinational company
A futures contract is one that is similar to a forward but has an independent third party that takes care of whether the consignor delivers the goods and the sender sends the money.
Just like the stock exchange works in the stock market, if you buy a futures contract, then you get the delivery of that goods, it is also the responsibility of the stock market, the responsibility of the stock exchange.
And if the seller gets the money, it is also the responsibility of the stock market, if you do not get your money, then you should not go looking outside. The stock market will impose a penalty on him. Will also take action against him from the stock exchange.
But you will get your money then there is an entity independent third party which keeps your interest secured when it becomes eligible then a forward contract becomes a futures contract in which interest is secured.
Still I know how it works in many stock market, what is its use, what is its practicality, it may not have been clear to you, so let’s now have a theoretical definition, now let us understand how futures work in the stock market. and what are its advantages and disadvantages.
First of all, now we understand the future with a simple example, practically. So let’s say there is a land which is worth ₹ 100000, the condition of the land is that the land will be given to the one who will have this token.
The one who has the token will get that land for free, so if you see the price of this token in yourself, then it is a piece of plastic which is probably not even worth a rupee, but because the one who has it
He will get the land for free of ₹ 100000, so in such a situation, this token has driven its price from the piece of land and its price has also become around ₹ 100000, so imagine if there is a condition with this token that the one who has this token has to Will get the land after 2 months.