Futures markets-role of the exchange

Futures markets-role of the exchange

In the United States currency futures contracts are traded on the International Monetary Market (IMM), a division of the Chicago Mercantile Exchange (CME).Currency futures are similar to forward contracts.They make it possible to lock in the price of a given currency where delivery takes place at a future point in time.Unlike a forward, futures contracts are standardized and are traded on an organized exchange.The ability to buy and sell futures contracts in an exchange market gives futures an advantage over forward contracts, namely, market liquidity.The holder of a futures contract can sell the contract in a liquid market, providing an additional advantage in the form of flexibility to alter the hedging or speculative position as conditions or needs change.

Corporate or institutional investor participants can benefit significantly by the hedging in financial futures.Trading currency futures can help a multinational company offset exchange risk related to an investment position.Portfolio managers can offset currency exposure positions or take on currency investment positions by buying and selling currency futures.

Futures contracts provide important services to those who make use of the exchange market.These include: 1)price discovery, that is, hedgers and speculators come together to discover the futures price of a currency; 2)liquidity, the ability of market participants to buy and sell at any time when the market is open for trading and 3)customer protection.Customer protection is provided by the enforcement of exchange rules.The CME makes use of the following to assure a high level of customer protection.

1.Margin requirements

The first level of protection in trading currency futures is the initial margin.The exchange enforces margin requirements relative to each clearing member firm.In turn that member firm enforces margin requirements on the customer (buyer or seller of the futures contract).These requirements minimize potential injury to customers in the event of any member firm’s financial reversal or insolvency.In addition to initial margin, there are maintenance margin requirements.These are based on day-to-day gains or losses in value of the futures contract.The exchange imposes these requirements on member firms, and the member firms enforce maintenance of margin requirements on customers by means of a daily settlement.

2.Protection against insolvency

The Commodity Exchange Act is the federal law that regulates commodities trading.This law requires that member firms of futures exchanges maintain capital at prescribed levels, and that customers’ funds be segregated from a member firm’s funds.This measure is intended to ensure that customers will not be adversely affected in the event of insolvency of an individual clearing member firm.

3.Protection against default

The CME Clearing House deals directly with its own member firms and not individual market participants.The exchange secures payment directly from clearing members.In this way the exchange does not rely on the trading public to make good on funds due to its member firms.This “independence” permits the CME to substitute itself in every transaction and make good payment to the member firm, regardless of any possible default by the party with the opposite position.

4.Clearing system

The clearing house functions as guarantor of performance for each futures and options contract.As delivery agent for contracts that entail physical delivery, the clearing house ensures timely delivery by the seller and full and timely payment by the buyer.Most futures contracts are liquidated before expiration.