How do freight derivatives like Forward Freight Agreements (FFAs) work?
The product descriptions for FFA swaps and options can be found here:  http://www.lchclearnet.com/freight/ffas/products.asp The index (e.g. the BFA) is based on the settlement prices of the P2, P2A, and C4 contracts and the panamax TC routes.  As such it's just a performance index and replicates the returns you'd get from holding a portfolio of the constituents. I think from the clearing descriptions everything should be clear.  The wording in the link on the Baltic Exchange website is a bit nebulous.  I think they mean standardised instead of specified.  Because that's what sets the FFABA apart from OTC agreements or OTC spot markets. Edit: For more information on financial instruments in general see the Handbook of Financial Instuments.  I haven't got the latest edition but I doubt he will mention FFAs, CFSAs, or anything that's specific to maritime markets but after all they're just plain forward agreements over a not-so-common underlying. "To answer this part of the question: ""How can you build an index based on shipping routes - what is the significance of that? Indexes are traditionally built based on companies: e.g. S&P Index is a basket of companies whose price varies. But here you need a basket of FFA contracts from different oil firms (Shell, BP), 5 year Shell FFA's, 10 year shell FFA's. Where do routes enter the picture? Let the tanker any route he feels like."" No, you don't get a basket of FFA contracts from given companies (such as Shell and BP). What you get are rates assessed by a panel of brokers for the main tanker routes (especially in the tanker market, there are comparatively few standard routes, because the major oil loading areas are also comparatively few). The panel will assess the spot and future markets on a daily basis, and issue the rates accordingly."
Short answer: Liquidity. Well, you have to see it from an exchange's point of view.  Every contract they put up is a liability to them.  You have to allocate resources for the order book, the matching engine, the clearing, etc.  But only if the contract is actually trading they start earning (the big) money. Now for every new expiry they engage a long term commitment and it might take years for an option chain to be widely accepted (and hence before they're profitable).  Compare the volumes and open interests of big chains versus the weeklies and you'll find that weeklies can still be considered illiquid compared to their monthly cousins. Having said that, like many things, this is just a question of demand.  If there's a strong urge to trade July weeklies one day, there will be an option chain.  But, personally I think, as long as there are the summer doldrums there will be no rush to ask for Jul and Aug chains. Can't I achieve the exact same effect and outcome by exchanging currency now and put that amount of USD in a bank account to gain some interest, then make the payment from one year from now? Sure, assuming that the company has the money now.  More commonly they don't have that cash now, but will earn it over the time period (presumably in Euros) and will make the large payment at some point in time.  Using a forward protects them from fluctuations in the exchange rate between now and then; otherwise they'd have to stow away USD over the year (which still exposes them to exchange rate fluctuations). "How do financial derivatives like futures help in price discovery? From what I understand, the prices of futures are decided after the parties ""discover"" the price they think is appropriate for the underlying asset after some time. Wouldn't taking a future's price and then valuating an asset like a cart in front of a horse or the tail wagging the dog? Please link all that you want to and correct me everywhere." "The answer is in your question: derivatives are contracts so are enforced in the same way as any other contract.  If the counterparty refuses to pay immediately they will, in the first instance be billed by any intermediary (Prime Broker etc.) that facilitated the contract. If they still refuse to pay the contract may stipulate that a broker can ""net off"" any outstanding payments against it or pay out using deposited cash or posted margins. The contract will usually include the broker as an interested party and so they can, but don't need to, report a default (such that this is) to credit agencies (in some jurisdictions they are required to by law). Any parties to the trade and the courts may use a debt collection agency to collect payments or seize assets to cover payment. If there is no broker or the counterparty still has not paid the bill then the parties involved (the party to the trade and any intermediaries) can sue for breach of contract. If they win (which would be expected) the counterparty will be made to pay by the legal system including, but not limited to, seizure of assets, enforced bankruptcy, and prison terms for any contempts of court rulings. All of this holds for governments who refuse to pay derivatives losses (as Argentina did in the early 20th century) but in that case it may escalate as far as war. It has never done so for derivatives contracts as far as I know but other breaches of contract between countries have resulted in armed conflict. As well as the ""hard"" results of failing to pay there are soft implications including a guaranteed fall in credit ratings that will result in parties refusing to do business with the counterparty and a separate loss of reputation that will reduce business even further. Potential employees and funders will be unwilling to become involved with such a party and suppliers will be unwilling to supply on credit. The end result in almost every way would be bankruptcy and prison sentences for the party or their senior employees. Most jurisdictions allow for board members at companies in material breach of contract to be banned from running any company for a set period as well. edit: netting off cash flows netting off is a process whereby all of a party's cash flows, positive and negative, are used to pay each other off so that only the net change is reflected in account balances, for example: company 1 cash flows netting off the total outgoings are 3M + 500k = 3.5M and total incomings are 1.2M + 1.1M + 1.2M = 3.5M so the incoming cash flows can be used to pay the outgoing cash flows leaving a net payment into company1's account of 0." "The VIX is a mathematical aggregate of the implied volatilities of the S&P 500 Index components. It itself cannot be traded as there currently is no way to only hold a position on an implied volatility alone.  Implied volatility can only currently be derived from an option relative to its underlying.  Further, the S&P 500 index itself cannot be traded only the attempts to replicate it.  For assets that are not tradable, derivatives can be ""cash settled"" where the value of the underlying is delivered in cash.  Cash settlement can be used for underlyings that in fact due trade but are frequently only elected if the underlying is costly to deliver or there is an incentive to circumvent regulation. Currently, only futures that settle on the value of the VIX at the time of delivery trade; in other words, VIX futures holders must deliver on the value of the VIX in cash upon settlement.  Options in turn trade on those futures and in turn are also cash settled on the value of the underlying future at expiration. The VXX ETF holds one to two month VIX futures that it trades out of before delivery, so while it is impossible to know exactly what is held in the VXX accounts unless if one had information from an insider or the VXX published such details, one can assume that it holds VIX futures contracts no later than two settlements from the preset.  It should be noted that the VXX does not track the VIX over the long run because of the cost to roll the futures and that the futures are more stable than the VIX, so it is a poor substitute for the VIX over time periods longer than one day. ""Underlying"" now implies any abstract from which a financial product derives its value." "No. Some grocery stores may discount specific products based on inventory to drive sales using ""loss leaders"" where the product is intentionally priced as a loss for the business. While commodity futures may impact some prices, I'm not sure one can easily extract the changes solely due to futures shifts." "Consider the futures market. Traders buy and sell gold futures, but very few contracts, relatively speaking, result in delivery. The contracts are sold, and ""Open interest"" dwindles to near zero most months as the final date approaches. The seller buys back his short position, the buyer sells off his longs.  When I own a call, and am 'winning,' say the option that cost me $1 is now worth $2, I'd rather sell that option for even $1.95 than to buy 100 shares of a $148 stock. The punchline is that very few option buyers actually hope to own the stock in the end. Just like the futures, open interest falls as expiration approaches." Wire transfers normally run through either the Fedwire system or the Clearing House Interbank Payments System (CHIPS). The process generally works like this: You approach a bank or other financial institution and ask to transfer money. You give the bank a certain code, either an international bank account number or one of several other standards, which informs the bank where to send the money.  The bank sends a message through a system like Fedwire to the receiving bank, along with settlement instructions.  This is where the process can get a bit tricky. For the wire transfer to work, the banks must have reciprocal accounts with each other, or the sending bank must send the money to a bank that does have such an account with the receiver. If the sending bank sends the money to a third-party bank, the transaction is settled between them, and the money is then sent to the receiving bank from the third-party bank. This last transaction may be a wire transfer, ACH transfer, etc.  The Federal Reserve fits into this because many banks hold accounts for this purpose with the Federal Reserve. This allows them to use the Fed as the third-party bank referred to above. Interestingly enough, this is one of the significant ways in which the Fed makes a profit, because it, along with every other bank and routing agent in the process, collects a miniscule fee on this process.  You'll often find sources that state that Fedwire is only for transferring large transactions; while this is technically correct, it's important to understand that financial institutions don't settle every wire transfer or payment immediately. Although the orders are put in immediately, the financial institutions settle their transactions in bulk at the end of the business day, and even then they normally only settle the difference. So, if Chase owes Bank of America $1M, and Bank of America owes Chase $750K, they don't send these as two transactions; Chase simply credits BAC $250K.  You didn't specifically ask about ACH transfers, which as littleadv pointed out, are different from wire transfers, but since ACH transfers can often form a part of the whole process, I'll explain that process too. ACH is a payment processing system that works through the Federal Reserve system, among others. The Federal Reserve (through the Fedline and FedACH systems) is by far the largest payment processor.  The physical cash itself isn't transferred; in simple terms, the money is transferred through the ACH system between the accounts each bank maintains at the Federal Reserve.  Here is a simple example of how the process works (I'm summarizing the example from Wikipedia). Let's say that Bob has an account with Chase and wants to get his paycheck from his employer, Stack Exchange, directly deposited into this account. Assume that Stack Exchange uses Bank of America as their bank.  Bob, the receiver, fills out a direct deposit authorization form and gives it to his employer, called the originator. Once the originator has the authorization, they create an entry with an Originating Depository Financial Institution, which acts as a middleman between a payment processor (like the Federal Reserve) and the originator. The ODFI ensures that the transaction complies with the relevant regulations. In this example, Bank of America is the ODFI.  Bank of America (the ODFI) converts the transaction request into an ACH entry and submits it, through an ACH operator, to the Receiving Depository Financial Institution (RDFI), which in this case is Chase bank. Chase credits (deposits) the paycheck in Bob's account.  The Federal Reserve fits into all of this in several ways. Through systems like Fedline and FedACH, the Fed acts as an ACH operator, and the banks themselves also maintain accounts at the Federal Reserve, so it's the institution that actually performs the settling of accounts between banks. "As mentioned in other answers, you find out by reading the Rulebook for that commodity and exchange.  I'll quote a couple of random passages to show how they vary: For CME (Chicago Mercantile Exchange) Random Length Lumber Futures, the delivery is ornate: Seller shall give his Notice of Intent to Deliver to the Clearing   House prior to 12:00 noon (on any Business Day after termination of   trading in the contract month. 20103.D. Seller's Duties If the buyer's designated destination is east of the western boundaries of North Dakota, South Dakota, Nebraska,   Kansas, Texas and Oklahoma, and the western boundary of Manitoba,   Canada, the seller shall follow the buyer's shipping instructions   within seven (7) Business Days after receipt of such instructions. In   addition, the seller shall prepay the actual freight charges and bill   the buyer, through the Clearing House, the lowest published freight   rate for 73-foot railcars from Prince George, British Columbia to the   buyer's destination. If the lowest published freight rate from Prince   George, British Columbia to buyer's destination is a rate per one   hundred pounds, the seller shall bill the buyer on the weight basis of   1,650 pounds per thousand board feet. The term ""lowest published   freight rate"" refers only to the lowest published ""general through   rate"" and not to rates published in any other rate class. If, however, the buyer’s destination is outside of the aforementioned   area, the seller shall follow the same procedures except that the   seller shall have the right to change the point of origin and/or   originating carrier within 2 Business Days after receipt of buyer’s   original shipping instructions. If a change of origin and/or   originating carrier is made, the seller shall then follow the buyer's   revised instructions within seven (7) Business Days after receipt of   such instructions. If the freight rate to the buyer's destination is not published, the   freight charge shall be negotiated between the buyer and seller in   accordance with industry practice. Any additional freight charges resulting from diversion by the buyer   in excess of the actual charges for shipment to the destination   specified in the shipping instructions submitted to the Clearing House   are the responsibility of the buyer. Any reduction in freight charges   that may result from a diversion is not subject to billing adjustment   through the Clearing House. Any applicable surcharges noted by the   rail carrier shall be considered as part of the freight rate and can   be billed to the buyer through the CME Clearing House. If within two (2) Business Days of the receipt of the Notice of Intent   the buyer has not designated a destination, or if during that time the   buyer and seller fail to agree on a negotiated freight charge, the   seller shall treat the destination as Chicago, Illinois. If the buyer   does not designate a carrier or routing, the seller shall select same   according to normal trade practices. To complete delivery, the seller   must deposit with the Clearing House a Delivery Notice, a uniform   straight bill of lading (or a copy thereof) and written information   specifying grade, a tally of pieces of each length, board feet by   sizes and total board feet. The foregoing documents must be received   by the Clearing House postmarked within fourteen (14) Business Days of   the date of receipt of shipping instructions. In addition, within one (1) Business Day after acceptance by the   railroad, the Clearing House must receive information (via a telephone   call, facsimile or electronic transmission) from the seller giving the   car number, piece count by length, unit size, total board footage and   date of acceptance. The ￼date of acceptance by the railroad is the   date of the bill of lading, signed and/or stamped by the originating   carrier, except when determined otherwise by the Clearing House. For some commodities you can't get physical delivery (for instance, Cheese futures won't deliver piles of cheese to your door, for reasons that may be obvious) 6003.A. Final Settlement There shall be no delivery of cheese in settlement of this contract.   All contracts open as of the termination of trading shall be cash   settled based upon the USDA monthly weighted average price in the U.S.   for cheese. The reported USDA monthly weighted average price for   cheese uses both 40 pound cheddar block and 500 pound barrel prices. CME gold futures will deliver to a licensed depository, so you would have to arrange for delivery from the depository (they'll issue you a warrant), assuming you really want a 100 troy oz. bar of gold: CONTRACT SPECIFICATIONS The contract for delivery on futures contracts shall be one hundred   (100) troy ounces of gold with a weight tolerance of 5% either higher   or lower. Gold delivered under this contract shall assay to a minimum   of 995 fineness and must be a brand approved by the Exchange. Gold meeting all of the following specifications shall be deliverable   in satisfaction of futures contract delivery obligations under this   rule: Either one (1) 100 troy ounce bar, or three (3) one (1) kilo bars. Gold must consist of one or more of the Exchange’s Brand marks, as provided in Chapter 7, current at the date of the delivery of   contract. Each bar of Eligible gold must have the weight, fineness, bar number, and brand mark clearly incised on the bar. The weight may be   in troy ounces or grams. If the weight is in grams, it must be   converted to troy ounces for documentation purposes by dividing the   weight in grams by 31.1035 and rounding to the nearest one hundredth   of a troy ounce. All documentation must illustrate the weight in troy   ounces. Each Warrant issued by a Depository shall reference the serial number and name of the Producer of each bar. Each assay certificate issued by an Assayer shall certify that each bar of gold in the lot assays no less than 995 fineness and weight of   each bar and the name of the Producer that produced each bar. Gold must be delivered to a Depository by a Carrier as follows: a. directly from a Producer; b. directly from an Assayer, provided that such gold is accompanied by   an assay certificate of such Assayer; or c. directly from another Depository; provided, that such gold was   placed in such other Depository pursuant to paragraphs (a) or (b)   above." "In short, yes. By ""forward selling"", you enter into a futures contract by which you agree to trade Euros for dollars (US or Singapore) at a set rate agreed to by both parties, at some future time. You are basically making a bet; you think that the dollar will gain on the Euro and thus you'd pay a higher rate on the spot than you've locked in with the future. The other party to the contract is betting against you; he thinks the dollar will weaken, and so the dollars he'll sell you will be worth less than the Euros he gets for them at the agreed rate. Now, in a traditional futures contract, you are obligated to execute it, whether it ends up good or bad for you. You can, to avoid this, buy an ""option"". By buying the option, you pay the other party to the deal for the right to say ""no, thanks"". That way, if the dollar weakens and you'd rather pay spot price at time of delivery, you simply let the contract expire un-executed. The tradeoff is that options cost money up-front which is now sunk; whether you exercise the option or not, the other party gets the option price. That basically creates a ""point spread""; you ""win"" if the dollar appreciates against the Euro enough that you still save money even after buying the option, or if the dollar depreciates against the Euro enough that again you still save money after subtracting the option price, while you ""lose"" if the exchange rates are close enough to what was agreed on that it cost you more to buy the option than you gained by being able to choose to use it." "MD-Tech answered: The answer is in your question: derivatives are contracts so are enforced in the same way as any other contract.  If the counterparty refuses to pay immediately they will, in the first instance be billed by any intermediary (Prime Broker etc.) that facilitated the contract. If they still refuse to pay the contract may stipulate that a broker can ""net off"" any outstanding payments against it or pay out using deposited cash or posted margins. The contract will usually include the broker as an interested party and so they can, but don't need to, report a default (such that this is) to credit agencies (in some jurisdictions they are required to by law). Any parties to the trade and the courts may use a debt collection agency to collect payments or seize assets to cover payment. If there is no broker or the counterparty still has not paid the bill then the parties involved (the party to the trade and any intermediaries) can sue for breach of contract. If they win (which would be expected) the counterparty will be made to pay by the legal system including, but not limited to, seizure of assets, enforced bankruptcy, and prison terms for any contempts of court rulings. All of this holds for governments who refuse to pay derivatives losses (as Argentina did in the early 20th century) but in that case it may escalate as far as war. It has never done so for derivatives contracts as far as I know but other breaches of contract between countries have resulted in armed conflict. As well as the ""hard"" results of failing to pay there are soft implications including a guaranteed fall in credit ratings that will result in parties refusing to do business with the counterparty and a separate loss of reputation that will reduce business even further. Potential employees and funders will be unwilling to become involved with such a party and suppliers will be unwilling to supply on credit. The end result in almost every way would be bankruptcy and prison sentences for the party or their senior employees. Most jurisdictions allow for board members at companies in material breach of contract to be banned from running any company for a set period as well. edit: netting off cash flows netting off is a process whereby all of a party's cash flows, positive and negative, are used to pay each other off so that only the net change is reflected in account balances, for example: company 1 cash flows netting off the total outgoings are 3M + 500k = 3.5M and total incomings are 1.2M + 1.1M + 1.2M = 3.5M so the incoming cash flows can be used to pay the outgoing cash flows leaving a net payment into company1's account of 0." You're talking about floating rate loans. It's so that the bond is marked back to market every 90 days. Any more often would be a hassle to deal with for everyone involved, any less often and they would be significant variance from LIBOR vs. the loan's specific rate. "Lol, wtf kind of question is this?    First off, there is no single ""derivatives market"".  There's listed derivatives (ETD's) and OTC.  Then you can break each of those broad markets down into forwards, futures, options (includes all exotics such as binaries, single barriers, double barriers, one touches, double no touches, knock ins, knock outs, reverse knock ins, reverse knock outs, window barriers, etc), and swaps (including swaptions).  All of these are product specific (FX, FI, Credit, Equities, Commodities, etc).... so its more appropriate to look at derivatives with respect to the market they are in rather than all derivatives across all markets.  Now to your question... your question makes absolutely no sense.  Are you wondering what the daily volume is?  Notional outstanding?  Total exposure?" as in, the person you made the agreement with can no longer fulfill the contract's requirements. It's the same thing as if they went bankrupt, you would have to pursue legal channels to recover your dues.      Granted in an FX forward you would only have to deliver your part at expiration, so you could hold out if you *know* the counterparty is dead/bankrupt. generally Forward P/E is computed as current price / forward earnings.  The rationale behind this is that buying the stock costs you the current price, and it gives you a claim on the future earnings.