Managing trading risk
A London International Financial Futures and Options Exchange case study

Page 1: Introduction

This case study examines the importance of futures trading and focuses more specifically on commodity futures trading. The futures market plays a key role in the modern economic system because it enables investors to trade in a cost efficient way and to eliminate some of the risk from their trading activity. Commodities lie at the heart of modern industrial society and include a wide range of...
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Page 2: What is futures trading?

A future is a contract to buy or sell a standard quantity of a specific commodity or financial instrument on a fixed date in the future at a price agreed today. Futures trading can be applied to most things which stand to rise or fall in value over a period of time. In addition to commodities, futures trading takes place for a wide range of securities and currencies. Organisations with long-term...
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Page 3: Benefits of LIFFE

Anyone who is exposed to potential losses caused by adverse movements on interest rates, commodity prices, or equities, may find LIFFE's contracts useful tools for risk management. Approximately 3,000 traders, working on behalf of over 200 member companies, trade contracts for their company or on behalf of their clients. These member companies represent a variety of sectors and geographical...
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Page 4: Ways of managing risk

In the commodity futures market there are three main types of activities which take place. hedging speculation arbitrage. Hedging accounts for the majority of traded volume, followed closely by speculation, whilst arbitrage accounts for only a small percentage of trading activity. Hedging Most large organisations buying particular commodities know that they will need a regular supply of the...
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Page 5: Grading and warehousing

When we examine the fascinating details of futures trading we can almost lose touch with the real commodities that are being traded. The trading in commodities must be carried out in the highest quality conditions. LIFFE ensures that the commodities being traded are tightly monitored and controlled. LIFFE has approved a number of authorised warehouses and warehouse keepers who are responsible...
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Page 6: Conclusion

This example can be used to illustrate the importance of the commodity futures market. Most business organisations cannot afford to be risk loving and therefore opt for risk aversion. The futures market enables these businesses to work in an ordered and disciplined market place in which the risk of rapidly changing commodity prices is greatly reduced. It reduces the risk of uncertainty from...
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Related: London International Financial Futures and Options Exchange
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