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Futures and forward curves

Normal and Inverted Futures Curves. Created by Sal Khan.

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  • blobby green style avatar for user Fernando
    At I don't understand the argument Sal makes about arbitrage. Can anyone explain please? Thanks
    (7 votes)
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    • hopper cool style avatar for user Ryan Logsdon
      I believe the arbitrage argument at is like this:

      In the case of apples, it's expected for the price to increase over time (inflation), so we should expect a "normal curve" -- the upward-sloping curve. However, if we see an inverted curve, that means that someone is willing to sell the apples to us at a cheaper price right here. And knowing that an apple's price should go up in price over time, we should be able to find another place where this will hold true. So we buy the future here at a cheap price (downward-sloping curve), and we find a market somewhere else with a normal, upward-sloping curve -- an increased price -- and we sell there.

      So the inferred part about his arbitrage statement is that there's a "market inefficiency" that lets us buy cheap right here, and we will then sell somewhere else for a higher price later.
      (10 votes)
  • leaf yellow style avatar for user trixhia_potteristic
    Hello, i would like to know where is the video explaining the downward sloping curve. thank you :)
    (8 votes)
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  • blobby green style avatar for user Cherine Jebali
    What's the difference between a forward curve and a spot curve ?
    (1 vote)
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    • duskpin seed style avatar for user davinci.rishi
      A spot curve will represent the spot prices across a chosen time frame, for example, a calendar year. A spot curve can only be drawn in retrospective i.e. only for a stretch of time in the past. A spot curve will never change once drawn, as it represents the spot price at various points in time across a chosen time frame.
      A forward curve represents the forward prices at chosen points of time, relative to today. A forward curve is always drawn starting at today's price and shows future prices. It is not constant. For e.g. the forward curve may show the price of a commodity for delivery as $10 two months from now, but a month later, this price may change.
      (4 votes)
  • leaf green style avatar for user 8a.luisf
    are the forward contracts are only used in commodities?
    (2 votes)
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    • blobby green style avatar for user newbreedusa
      Forward contracts exist for all asset classes and can be found as Exchange listed contracts in the form of Futures, or Over-the-Counter (OTC), traded between banks, investment banks, market makers, etc., and their clients, as long as the client has the capability which is checked by the risk department of the market maker making the price. The risk department will check the credit of the client, and then enter into forward contracts if the client asks for a price or needs a forward contract deal structured.
      (2 votes)
  • starky ultimate style avatar for user Sudhanshu Sisodiya
    what determines these prices?
    (2 votes)
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  • blobby green style avatar for user Will.H.Ashman
    Can you explain the terms 'contango' and 'backwardation'? Is it to do with futures prices trading above or below the expected spot price at contract maturity?
    (0 votes)
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  • orange juice squid orange style avatar for user Ankit Agrawal
    if future price were going down It will be desirable for the buyer. Is the argument this "If one party doesn't want to get into contract the other won''t be able to"
    (0 votes)
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  • leafers ultimate style avatar for user go floss
    if the buyer and seller sell their contracts on the market, do they make or lose money? your previous video suggests they do not.

    so how do speculators make or lose money?
    (0 votes)
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Video transcript

Male voiceover: Let's see if we can understand a thing or two about Futures Curves and I've drawn two futures curves here and really all they show is the different settlement prices for the different delivery dates of futures. So, let's say that this orange curve is one of them. What this says is if today, if for delivery today, we wanted to buy or sell an apple, the market rate is 10 cents a pound. This isn't the Futures contract at all. This is actually called the Spot Price. It's essentially the market price for that commodity or that security today. We're just using the example of apples. This tells us at time 0, you can buy or sell an apple, based on the current market for 10 cents. Now, when we move to 1, the way I've labeled this axis, it says one month from now. This is not saying that the market price is going to go up one month from now. This is saying that today, if you were to go into the Futures market and say, "I want to sell," or, "I want to buy apples "one month from now. "What type of a settlement price "can I get on my Futures contract?" And based on this Futures Curve, it looks like we could do about 12 cents. I'm gonna repeat what I just said. This is not saying that a month from now that the market price that the Spot Price is going to move up. Only this time 0 is the Spot Price. What this is saying is right now, the market is saying, "If you want to enter "into a Futures contract for delivery a month from now, "that delivery price will be 12 cents. "If you wanna deliver two months from now, that delivery price might be around 15 cents. "If you wanna deliver eight months from now, "that delivery price might be something like 20 cents." If you wanted to show movement, let's say all of a sudden, people just get more bullish on apples or there's some new diet that tells everyone that apples help you lose weight, what you would probably see is this entire curve would shift up So, regardless of delivery date, you would probably see this entire curve shift up because people would want apples across the entire Futures Curve. This one that we're highlighting right now, I've drawn two Futures Curves. I've drawn an upwards sloping orange one and I've also drawn a downward sloping blue one and I'll focus on that one in the next video but this upward sloping is kind of a normal curve and it's actually called that. It's a Normal Curve because this is what you actually expect for most types of commodities. You could imagine why. If this wasn't upward sloping, there would actually be no reason for you to hold onto something. Especially, if this was downwards sloping, you'd be like, "Wow. "If for future delivery dates, "I'm getting lower and lower prices, "why don't I just sell now?" And that would actually create downward pressure on the current Spot Price and you could of course, make the arbitrage arguments I made in previous videos, why you shouldn't in a theoretical setting, see a downward sloping Futures Curve. What we're gonna talk a little bit about on the next video, is maybe why you would see a downward sloping Futures Curve where the delivery price for delivery further out than the Spot Price or for further out months than nearby months is actually lower and just to give you a little terminology, this type of curve right here is called an Inverted Curve and I'll talk in the next video on why you might see one of those.