A commodity trader locks in a sale price on 10,000 barrels of crude oil using a forward contract. Three months later, oil drops 20%. The trader pockets the difference, no margin calls, no exchange involvement, just a private agreement. That single transaction touches cost-of-carry pricing, counterparty risk, and the mechanics of over-the-counter (OTC) derivatives. OTC markets let counterparties customize terms outside an exchange, which is why bespoke forwards dominate institutional hedging despite carrying bilateral credit risk. Every concept in this lesson flows from that kind of decision.
A forward contract is a private, customized agreement between two parties to buy or sell an asset at a specified price on a future date. No exchange is involved. Terms (quantity, delivery date, settlement method) are negotiated directly.
A futures contract does the same economic job but through an exchange. Contracts are standardized. A clearinghouse sits between buyer and seller, eliminating counterparty risk. Futures use daily settlement (marking to market), the operational difference that drives everything else.
Common mistakes
- Restoring margin to maintenance instead of initial margin. When a margin call hits, you must restore to the initial margin level, not the maintenance margin. If initial is $10,000, maintenance is $7,500, and your balance is $6,800, the deposit is $10,000 - $6,800 = $3,200.
- Confusing FRA notation. A "3x9 FRA" covers a 6-month loan starting in 3 months, not a 3-month loan starting in 9 months or a 9-month loan starting in 3 months. Subtract the first number from the second (9 - 3 = 6) to get the loan period.
- Reversing the hedge direction. A short stock position needs long calls for protection (calls gain when price rises, offsetting short stock losses). A long stock position needs long puts. The exam reverses these. Buying puts for a short stock position does nothing useful, it doubles your directional bet downward.
Bottom line
- Forwards are OTC and customized with bilateral counterparty risk; futures are exchange-traded and standardized with daily settlement through a clearinghouse.
- Marking-to-market shifts levels: futures price exceeds forward when spot and rates are positively correlated, equals it when uncorrelated, and falls below it when negatively correlated.
- Forward price = Spot x e^((r + storage costs - convenience yield) x T); physical-asset curves also reflect supply/demand forecasts, storage and convenience differentials, and short-sale frictions.
- Long-term futures exposure requires rolling front-month into deferred contracts, so the roll schedule drives long-run returns; FRA notation "AxB" means settlement in A months over a (B minus A)-month loan.
Exam shortcut
When the exam shows a margin call scenario, go straight to initial margin minus current balance. Do not compute maintenance minus current balance, that is always the trap answer. For FRA notation, remember: "first number is when, difference is how long." A 3x9 starts in 3 months and lasts 6. A 6x12 starts in 6 months and lasts 6. Subtract to get the loan period.
The full lesson (about 5,619 words, 37 min read) adds 2 worked examples, all 7 common mistakes, a self-check, free in the app.
Learning objectives
- defining alts
- blurred lines
- history us
- history asia
- risk return characteristics
- goals
- buy sell side
- service providers
- legal structures
- fund types
- fund features
- fund terms
- drawdown fees
- waterfall calcs
- hedge fund fees
- fees and behavior
- return math
- irr
- irr problems
- modified irr
- other measures
- j curve
- notional principal
- return distributions
- moments
- covariance correlation
- beta autocorrelation
- std dev variance
- normality testing
- market efficiency
- time value
- forward rates
- arbitrage
- binomial trees
- single factor models
- hypothesis testing
- sampling problems
- forwards vs futures
- forward foundations
- forwards on rates
- carry forwards
- managing long short
- option exposures
- rate options
- rate swaps
- option pricing
- risk measures
- var
- benchmarking
- ratio measures
- risk adjusted
- pricing data
- appraisals smoothing
- alpha beta overview
- estimating alpha
- return attribution
- statistical issues
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