Futures contracts are one of the most important financial innovations in history, but they are often misunderstood. These contracts are used to transfer risk between different parties. Futures markets originated as a way for producers to stabilize their income and/or raw material supply amid market fluctuations, but it soon grew into a way for speculators to bet on the direction of a given commodity. These two market forces interact to create the futures markets that we know today and each plays a critical role in the market’s dynamics.
Forward contracts vs. Futures contracts
Before the North American futures market originated some 150 years ago, farmers would grow their crops and then bring them to market in the hope of selling their inventory. But without any indication of demand, supply often exceeded what was needed and unpurchased crops were left to rot in the streets! Conversely, when a given commodity – wheat, for instance – was out of season, the goods made from it became very expensive because the crop was no longer available.
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