Physical Delivery

Futures Contracts  and Spot products,  expiring on the Mercantile Exchange of Belize will be settled through Cash Settlement ONLY. Unlike many other futures exchanges, upon the expiration of contracts on the Mercantile Exchange of Belize,  all contracts will culminate in cash settlement rather than physical delivery (on the last day of trading for every contract, the final price traded becomes the settlement price).  Should a trader be long (having bought) a futures contract at that time, he would realize a profit should the settlement price be higher than his purchase price, or a loss if the settlement price is lower than the purchase price.  If the trader had been short (having previously sold) he would realize a loss if the settlement price is higher than his sale price, or a profit if the settlement price is below the original sale price.  Arbitrage between contracts traded in the local market and contracts traded on international markets would keep the prices of local markets in line with prices of those contracts traded elsewhere. Experience on exchanges like the Chicago Mercantile Exchange has shown that cash-settlement-priced futures contracts track both spot and other futures prices very closely.

Because the contracts culminate in cash settlement, businessmen who use the underlying instrument would not buy or sell these contracts for ultimate delivery.  Rather, they would utilize parallel hedges – buying or selling a quantity of futures contracts that matched their physical requirements for a settlement date that was beyond the date of their actual requirement.  Then, when it was time to satisfy their spot requirement, they would offset their futures contracts.  The additional cost incurred in the spot market would be offset by a gain in the futures market.  (Once the businessman executes a futures contract, he is, in effect, “locking in” a price for the instrument – additional costs or losses are offset by equivalent gains in the futures market, but lower costs or windfall gains in the spot market are also offset by losses in futures.)

As an example, assume that an exporter dealing in US Dollars arranges for a sale of export goods worth EUR 400,000 (approximately USD 300,000 at a spot rate of USD 1.33 per EUR).  Delivery (and payment) will take place in 2 months on May 31.  The exporter is worried that the US dollar might depreciate vs. the euro between now and delivery, resulting in net revenues that are less than if he could receive payment today.  To protect himself, he would sell  futures contracts worth 400,000 euros at a price near today’s spot exchange rate.  If the dollar does depreciate, say, to USD 1.45 per euro in the spot market, the exporter would realize only USD 275,000 (approximately) for the export transaction (a loss of 25,000 dollars).  However, the futures price would also declined by approximately USD .08 per Euro (from 1.33 to 1.45).  He would offset his short futures contract by buying it back, netting a profit of USD 25,000 on the futures transaction.

Of course, if the dollar appreciated during the period, the exporter would realize more dollars at the time of delivery, but this gain would be offset by a loss on the futures transaction.  However, by hedging in the futures market, the exporter has effectively “locked in” an exchange rate for his goods at time of delivery, thus virtually eliminating his exchange rate risk.

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