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Chapter 16: Problem 2

Why might a person buy a futures contract?

Short Answer

Expert verified
A person might buy a futures contract primarily to hedge against risk. The contract allows one to mitigate the risk of experiencing losses due to unpredictable fluctuations in prices. In essence, it provides a financial cushion against the uncertainties of marketplace dynamics.

Step by step solution

01

Definition

A futures contract refers to a legal agreement to buy or sell a particular commodity or asset at a predetermined price at a specified time in the future.
02

Purpose

The purpose of such a contract is to hedge or mitigate risk associated with unpredictable changes in the price. This works both ways - where one can protect oneself from potential price increase or from a potential price drop.
03

Advantages

Buying a futures contract offers some individuals and organizations the opportunity to hedge against potential risks. For instance, an investor might buy oil futures to protect from the risk of oil prices increasing. Likewise, a farmer might sell wheat futures to secure a price for their crop beforehand, in case the price of wheat drops before they can sell their harvest.

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