Contracts

__Contracts__ are agreements between traders to do something at a point in time. The value of a contract is dependent on an underlying asset's value, and the underlying asset can be a security, a commodity, a currency, an index, or even another contract.

Contracts can be settled for the _physical exchange of an item_ or the _electronic delivery of a financial instrument_. Contracts can also be settled for _cash_, with the amount calculated based on a formula. Given these three types of contracts, if you were to enter into a contract that calls for you to give another party a specific amount of gold, what form would your settlement take?

Incorrect. Since you would be exchanging gold at the conclusion of the period, settlement would not be taking place for cash. You would be giving the other party an item. However, if the contract had been tied to the _price of gold_, settlement could have taken place in cash.

Incorrect. At the end of the contract, you would be satisfying your obligation by providing an item to the other party. Gold is not a financial instrument. Financial instruments do not really exist in a physical sense.

That's right! At the end of the contract's term, your exchange of gold to the other party in the transaction would constitute a physical settlement.

Contracts that provide for immediate delivery are referred to as _spot contracts_, and they trade in spot markets. Now, "immediate delivery" does not necessarily suggest it will be delivered at that very point in time. It generally means delivery within three days but depends on the market. The value of all other contracts is related to events that will occur in the future. These contracts involve _futurity_.

To better grasp the concepts of futurity and spot markets, suppose you work for a manufacturer of children's toys and wood is a key component of the production process. The December holiday season is the company's peak selling time, and raw materials are sourced well in advance of production. If you were to contract for the purchase of a large quantity of wood in April, for delivery several months later, what type of contract would you enter into?

Incorrect.

Exactly!

Since a contract that would allow the company to buy wood and take delivery at a point in the _future_ would be optimal for the company's production schedule, entering into a spot market transaction would _not_ be your desired course of action.

To summarize: [[summary]]

Cash

Delivery of a financial instrument

Physical exchange

A contract in the spot market

A contract that involves futurity

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