The Commercial Markets
Cash Market and Future Market are both commercial markets. The cash market is for on-spot payment while in the case of future market payment is done after a time span in the future. Both are important in the share market. The cash market and the futures market are veiled by the buyers and sellers of shares according to their preferences. While specific companies also might keep their shares on the basis of either of these two.
We will learn what the cash market is and what the future market is, also we will illustrate the difference between these two markets.
Cash Market Meaning
The cash market is the marketplace in which financial tools like commodities and securities are being purchased and are received in the exchange for cash, these cash markets are also known as spot markets as the transactions are settled on the spot.
Cash market transactions can also be conducted either in a regulated environment like in a stock exchange or in some other environment like over-the-counter transactions which are deemed as unregulated environments.
What is a Cash Market?
Cash market means – the marketplace where the commodities, securities are being paid for and these are received at the point of sale. For example - in the stock exchange – the prevailing cash market is a general scenario here as the investors receive the shares immediately in exchange for cash.
Cash markets are called spot markets because their transactions get settled "on the spot." This is in contrast with futures markets, where the buyers pay for the right to receive the goods, such as a barrel of oil, at a specified date somewhere in the future.
Note: Students should not confuse the cash market with the money market. The money market involves trading of the cash equivalents (they are very short-term debt instruments) like Treasuries and commercial paper.
Example of a Good Cash Market
‘Ajmer Ltd.’ is a manufacturing company that uses wheat in several of its food items. Rather than cultivating the wheat directly, Ajmer relies on the cash market in order to provide their wheat supplies. It purchases a good amount of wheat each month from the farmers, in return for which the company pays them in cash and they also stockpile their products in their warehouses.
Ajmer also uses the forward contracts to secure the right to purchase the wheat at a predetermined price in the future times. In these cases, Ajmer does not take possession of the wheat during the point of sale. These transactions take place on an OTC (over-the-counter) basis between Ajmer Ltd and another specific dealer or food broker.
Future Market Meaning
Future Market is basically a commercial marketplace where future agreements are being purchased and sold. The word ‘futures contract’ means an agreement that is performed in the prospect.
This is an agreement between two different parties in which one party gives his or her consent for the purchase of a particular amount of a good or financial tool at the consented cost price and at the shipment price of the material. This is done at a succeeding date (pre-specified) in prospect.
What Is a Future Market?
A futures market is the auction market where the participants which include the buyer and the seller buys and sells the commodity and all the future contracts for the delivery on a specified future date. Futures are the exchange-traded derivatives with contracts that are locked up in the future for delivery of the commodity is secured at a price that is set today.
Examples of futures markets are - New York Mercantile Exchange (NYMEX), the Kansas City Board of Trade, the Chicago Board of Trade (CBoT), Chicago Board Options Exchange (CBOE), the Chicago Mercantile Exchange (CME), and the Minneapolis Grain Exchange.
Originally, trading is carried through open outcry and the use of hand signals in the trading pits which is located in the financial hubs like in New York, Chicago, and in London. In this 21st century, like most other markets, even futures exchanges have become primarily in electronic mode.
Future Market Example
A coffee farm sells black coffee beans at 12 per pound and thus both are making a profit at that stipulated price, they will probably want to keep these costs at a fixed rate. The investor agrees to this - if the price for coffee goes below the fixed or set rate, the investor will agree to pay the difference to the coffee farmer.
If the price of the coffee goes higher than at this certain price, the investor will get to keep the profits. For the roaster, the price of the green coffee goes above the agreed rate, the investor will pay the difference and the roaster will get the coffee at the determined or predictable rate. If the price of green coffee becomes lower than the agreed-upon rate, then the roaster will pay the same price to the investor and thereby the investor will get the profit.
The difference table – Cash Market Vs Future Market
Point of Difference | Cash Market | Future Market |
Define | The cash market is referred to as the marketplace where financial tools like commodities and securities are being purchased and are received in exchange for goods and services. | Future Market is the commercial marketplace where the future agreements are purchased and sold in that particular marketplace. |
What is the need for the purpose? | In order to buy the trades and shares in the market. | For speculations and for hedging activities. |
Ownership of these shares | When anyone will hold the shares then he/she is regarded as the shareholder. | No option to become a shareholder. |
Delivery | Delivered on T+2 days | No delivery will take place. The future contract expires on the expiration date. |
Payment | The full amount is to be paid during the time of payment. | Only the margin money is required to be paid in future contracts. |
Lot size | You can buy a single share of the company. | One must buy a minimum lot of size which is already defined. |
Holding period of shares | In the cash market, you can hold the shares for a lifetime after buying them. | In the future market, you need to settle the contract on the expiration date (maximum time is three months) |
FAQs on Cash Market Vs Future Market
Question1: What are hedging activities?
Answer: Hedging Activities means any type of transaction which is intended to reduce the economic risk of the ownership to which Common Stock is related (this includes, without limitation, the sale of any option or any contract for the purchase or the purchase of any option or the contract to sell) that would either directly or indirectly affect the economic scenario.
Question2: Why is the future price lower than cash or spot price?
Answer: When the futures contracts have lower prices than the spot price, traders will deliberately sell the short asset at the spot price and buy the futures contracts for a profit in this case. The main cause of backwardation in the commodities' futures market is the shortage of the commodity in the spot market.
Question3: What is the role of the cash market?
Answer: The role of the cash market is that it serves as a market for unsecured, overnight loans between the banks. The weighted average of the respectable interest rates on these loans is known as the cash rate, the Reserve Bank's operational target for the monetary policy which is an important financial benchmark in this area.
