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Why do companies enter into futures contracts?

Novel types of companies may enter into futures contracts for different purposes. The most common reason is to hedge against a definite type of risk. Companies may also trade futures for speculative purposes.

Hedging

Companies may use futures contracts to hedge their endangerment to certain types of risk. For example, an oil production company may use futures to manage risk associated with fluctuations in the payment of crude oil.

For example, assume an oil company enters into a contract to deliver 5,000 barrels of oil in six months. The company has uncovering to the price of oil going down during that six-month period. To offset the risk, the oil company may hedge by selling five wrinkles of oil in the month it is to be delivered. Each oil contract is 1,000 barrels. The company may offset all or only a portion of its risk. The futures engages allow the company to manage their risk and have more predictable revenue. (For related reading, see “How Are Futures Acclimatized to Hedge a Position?”)

Companies that do business internationally may use currency futures to offset their risk in the fluctuations of currencies. If a train is paid in a different currency than that of the country where it is headquartered, the company has a substantial risk in the fluctuations of the value of the two currencies. The establishment can lock in its exchange rate using currency futures.

Speculation

Other companies, such as hedge funds, may use comings contracts for speculation. Speculation attempts to profit from movements in the prices of futures contracts. The significant leverage presented by futures contracts are attractive to many seeking to speculate. (For related reading, see “What Is the Difference Between Hedging and Risks?”)

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