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Current time:0:00Total duration:2:41

Video transcript

you might be wondering why the exchange would be willing to take on the counterparty risk for people trained exchanging these kind of standardized futures contracts and the first reason is that the exchange actually stands to make a lot of money what he can do is tell these people who want to buy apples in the future he could say for example hey you can you could enter into a futures contract with a settlement price of 22 cents per pound so that's what they're going to have to come to the table with so that is 22 cents per pound and he could tell the people who are going to deliver the apples that when you deliver the apples the settlement price is 20 cents per pound is 20 cents per pound and so essentially when the settlement occurs he's going to be able to make a 2 cent profit he's going to make a 2 cent profit let me review that again if he only has to pay these guys 20 cents a pound for the apples and these guys are paying 22 cents a pound for the apples and maybe I should make this error go in this direction because this is the flow of the actual money if these guys are going to pay 22 cents for the apples and then as the exchange this guy only has to give 20 cents to the farmers he's going to make 2 cents profit and on on futures contracts on a thousand pounds of apples that's going to be 20 dollars for each of those contracts so that's going to be 20 dollars $20 per 20 dollars per contract and he's going to be doing this night and day trading with all of the different farmers and all of the different customers and even some speculators who might want to do this so maybe if the spread if we kind of can maintain this 2 cents bread he'll keep making 20 dollars every time one of these future contracts exchange hands now the other way that he's going to protect himself against losses is he's going to make each of these parties set aside some money in case in case the futures contract price moves against them and this money that they have to set aside is called margin and I'll explain this in more detail in a future video but what it essentially is is the amount of money that this guy or the the amount the the largest amount that this guy thinks that the futures price might move by the contract price might move by any given day and so he has a cushion he can actually use the margin as kind of insurance so we can make sure that on the settlement date both parties will kind of be able to meet their obligations and I'll go into more detail that on the next video on exactly how margin works