- Global Frameworks: US CMA Part 2 (Corporate Financial Decisions), CIMA Financial Strategy (F3).
1. Futures vs. Forwards Operational Structural Comparison
Futures contracts are standardized forward commitments traded on regulated exchanges. Key operational distinctions include:
| Structural Trait | Forward Contracts | Futures Contracts |
|---|---|---|
| Contract Size / Terms | Custom-tailored to client needs | Standardized lots and fixed dates |
| Counterparty Risk | Borne directly by counterparties | Assumed by Central Clearing House |
| Cash Settlement | Single cash payment at maturity | Daily Mark-to-Market cash transfers |
| Market Liquidity | Illiquid; highly difficult to exit | Liquid; easily offset before maturity |
2. The Mechanics of Daily Margining and Mark-to-Market
To eliminate counterparty default risk, futures exchanges use a daily margining system:
- Initial Margin: The minimum cash deposit required to open a futures position.
- Maintenance Margin: The absolute baseline equity level required to keep a position open (typically 70-80% of the initial margin).
- Margin Calls: At the close of each trading day, the exchange marks positions to market prices. If a trader’s account balances drop below the maintenance margin boundary, they receive a margin call requiring them to deposit cash to restore the account to the Initial Margin level (not the maintenance level). Failure to do so results in immediate liquidation of the position.
3. Corporate Hedging Frameworks
Corporations use futures contracts to lock in costs or revenues:
- Short Hedge (Sell Hedge): Used by entities that own an asset or expect to harvest/produce a commodity in the future (e.g., a copper mining firm). Selling futures protects the firm against falling prices.
- Long Hedge (Buy Hedge): Used by entities that must purchase an asset or raw material in the future (e.g., an airline needing jet fuel). Buying futures protects the firm against rising prices.
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