Summary

Futures markets exist to facilitate the hedging of price risk. If there is an imbalance of hedgers, short and long, then speculators need to enter the futures market to correct these imbalances and futures prices will reflect this activity (for example, contango). This chapter introduces the mechanics of futures and forwards along with some institutional detail and provides a sound theoretical basis for pricing these derivative securities. We introduce as well plain vanilla swaps and develop their pricing and apply all of these models to practical applications targeted to portfolio management. The development of these models link up well to the concept of hedging risk, which has been a recurrent theme throughout this book and is the subject of Chapter 18.