RISKS OF DEALING IN FUTURES CONTRACTS

The risk from investing in futures contracts to a large extent depends on how the contracts are used. If a contract is used to offset another investment position, then a hedge is initiated and the risk of an investor’s position is reduced. For example, a farmer concerned about the price that would be received for a crop at the time a price ahead of time. Using a futures contract in this manner actually reduces risk. The farmer has locked in a price and essentially eliminated any uncertainty as to the revenues that will be received from selling the crop. Likewise, a business that plans to make a large purchase of goods from a foreign manufacturer in the home currency of the manufacturer runs the risk that the foreign currency may appreciate against the dollar before payment is due. To reduce the risk of buying the goods, the business can purchase a futures contract on the foreign currency, which would affect any changes in the rate of exchange between the dollar and the foreign currency. An investor holding a large portfolio of common stocks can engage in a hedge by selling one or more futures contracts on a stock index.