Cash Settlement is a method of settling forward contracts or futures contracts by cash rather than by physical

delivery of the underlying asset. The parties settle by paying/receiving the loss/gain related to the contract in cash
when the contract expires.
In forward or future contracts, the buyer agrees to purchase some asset in the future at a price agreed upon today. In
physically settled forward and future contracts, the full purchase price is paid by the buyer, and the actual asset is
delivered by the seller. For example: Company A enters into a forward contract to buy 1 million barrels of oil at
$70/barrel from company B on a future date. On that future date, Company A would have to pay $70 million to
company B and in exchange receive 1 million barrels of oil.
However, if the contract was cash-settled, the buyer and the seller would simply exchange the difference in the
associated cash positions. The cash position is the difference between the spot price of the asset on the settlement
date and the agreed upon price as dictated by the forward/future contract. Continuing from the example above, if on
the settlement date the price of oil was $50 per barrel, the buyer, instead of paying the seller $70 million, would pay
him $20 million. This is the difference between the price of 1 million barrels on that day and the agreed upon price -and the seller would not deliver any oil to the buyer. If, on the other hand, the price of oil was $80 per barrel, the seller
would pay the buyer $10 million in cash and deliver no oil.
It may seem confusing as to why the cash position is the difference between the spot price at settlement and the
agreed upon forward/futures price. Using the example above again, consider if the spot price of oil was $50 per
barrel, and the contract were physically settled. It would pay the seller $70 million, and received 1 million barrels in
return. However, themarket value of the oil is only $50 per barrel, meaning it paid more than the spot (market) price
for oil. In other words, if Company A were to sell the oil immediately after it received the oil, it would only receive $50
million, incurring a loss of $20 million. The same principle holds true if the spot price of oil is $80 per barrel at expiry;
rather than having a loss, Company A now has a profit.

Why do parties use cash settlement?

Cash settlement is useful and often preferred because it eliminates much of the transaction costs that would
otherwise be incurred when physically delivering a good. For example, a futures contract on a basket of stocks such
as the S&P 500 (SPX) will always be cash settled because of the inconvenience, impracticality, and extremely high
transaction costs associated with delivering shares of all 500 companies. Because the costs associated with cash
settled contracts are lower, it appeals to both hedgers and speculators.
Cash settlement also helps reduce credit risk for futures contracts. When entering into a futures contract, each party
must deposit money into a margin account where gains and losses are paid into or taken out of. Futures contracts
are cash settled daily and gains/losses are received/paid each day, eliminating the chance that a party will be unable
to pay.
Most forwards and futures on financial assets are cash settled. For instance, forward rate agreements, which are
forward contracts on an interest rate, are always cash settled because the underlying is an interest rate, which is not
physically deliverable. Commodities, while often physically settled, can also be cash settled as long as an observable,
undisputed measure of the spot price is agreed upon beforehand. Cash settling commodities lets companies reduce
the cost ofhedging.

How does cash settlement work?

A quick example would help illustrate the point. Assume Company Z, an airline company, purchases its fuel from
local, familiar dealers, but wishes to hedge against rising fuel costs. It buys (take the long position) a futures contract
at the price of $50 per barrel to lock in its purchase price. However, it has a long established relationship with local
suppliers, and it would prefer to continue purchasing from its established suppliers rather than receive the fuel from
the seller of the futures contract.
If the futures contract was physically settled, at expiry Company Z would pay the previously agreed upon futures
price, and receive the actual fuel from the seller regardless of the spot price (current market price). If the spot price
was $75 a barrel, Company Z has a profit of $25 per barrel, since it pays only $50 per barrel rather than $75. If the
spot price was $25 a barrel, Company Z has a loss of $25 a barrel because it must pay $50 a barrel when it could
have only paid $25 had it not entered into the contract. By entering into the futures contract, Company Z locks in its
purchase price of fuel, effectively removing any uncertainty about the cost of the fuel.
However, if the contract was cash settled, Company Z would receive the difference in cash between the spot
price and the futures price. If the spot price at expiry is $75, Company Z has again earned a profit of $25 per barrel.
This is because it only needs to pay $50 per barrel, but can immediately sell it for $75, turning a $25 immediate profit.
This is where the convenience of cash settlement makes it desirable. Rather than paying $50 per barrel and receiving
the actual fuel, in a cash settled contract the seller of the contract would simply pay Company Z $25, or the difference
between the spot and futures price. This allows Company Z to then purchase fuel from its established supplier at the
spot (market) price of $75. Since it received the $25 per barrel from the seller of the futures contract, the final net cost
to Company Z remains $50 per barrel.
If the spot price were to decrease to $25 per barrel, then Company Z has a loss (since it could buy fuel in the open
market for $25, but has locked in the purchase price at $50) and must pay the seller $25. However, despite the loss, it
can now buy fuel at the spot price of $25 per barrel, and thus again the total cost is $50 per barrel.
bestcashloans.org.uk

A commodity is a product that is sold without differentiation by all suppliers. Although any good or service can be a
"commodity" if it is sold by many suppliers in an undifferentiated fashion, the term commodity generally refers to
physical goods which are the building blocks of more complex products, and which are traded on commodities
exchanges such as the Chicago Board of Trade (CBOT) or the New York Mercantile Exchange (NYMEX). Some
examples of commodities include iron ore, crude oil, sugar, soybeans, aluminium,rice, wheat, gold and silver.
Investing in commodities is done primarily through the trading of futures contracts.

How One Invests in Commodities

As the prices of commodities have such broad-reaching effects on the economy, an investor can take advantage of
changes in commodity prices in several ways.
Generally speaking, coverage or discussion of commodity prices is in terms of futures prices, wherein the buyer is
paying for a specified quantity of the commodity for delivery at a later, predetermined date. It should be noted,

however, that seldom does a futures investor actually receive the commodity in question, but instead sells it to some
other buyer upon the contract's expiration (if not before). Futures trading reduces the risk for producers of
commodities - a good example is a farmer, who must risk the cost of producing agricultural goods without knowing
the price they will earn on the market several months later.[1] In this case, futures contracts assure the farmer that he
will be paid for the commodity when it is ready for delivery. For a full discussion of commodity (and other) futures
contracts and the underlying mechanisms behind them, see the article on futures.
Spot prices are another means of valuing commodities, wherein the buyer pays the commodity's producer for the
immediate delivery of the product. Spot prices can be thought of as the amount of money a buyer would pay a
producer for the latter to throw the commodity into the back of the former's truck right now.
A more indirect way to invest in commodities would be to buy or sell the stocks of companies that are most affected
by the commodities in question. For example, one could bet on an increase in Oil Prices by buying stock in Exxon
Mobil (XOM) orBP (BP). By contrast, if a company has a harder time passing the cost of the commodity onto the
consumer would likely see a decline in net income with higher commodity prices. As such, one could take advantage
of climbing Oats Prices byshort selling stock in General Mills (GIS).

Delivery Dates
Since a commodity is by definition a tangible good, its trading is not a continuous and ongoing activity with a
theoretically never-ending trading horizon (like that of a stock) as the good must be at some point delivered in order
have any usefulness. As such, commodities futures contracts have typically two or more delivery dates per year. For
example, cornis delivered in March, May, July, September, and December of every year. Investing in a futures
contract necessarily means that the contract will expire when it is time for the commodity to be delivered.
For a full list of delivery dates for the major commodities, see Commodity Delivery Dates.

Commodities Futures Ticker Construction

Unlike stocks, which have a single letter abbreviation for each publicly traded company, commodities tickers must
specify not only the commodity but also the delivery date and year of the futures contract. As such, commodity tickers
are constructed in multiple parts.

Elements of a Commodities Futures Ticker

1. Base Symbol All commodities have a specific and unique base abbreviation (similar to a stock ticker).
This is almost always a one or two letter combination. For example, corn is abbreviate C while crude oil is
abbreviated CL.
2. Delivery Month This part of the ticker specifies for which delivery month this specific futures contract is
for. For example, an investor wanting to purchase a futures contract for wheat would need to specify
whether he wanted to purchase a contract with a March, May, July, September, or December delivery date.
Denoted by a single letter for each month, all commodities futures contracts use the same abbreviation
code, a table for which can be found at the bottom of this section.

3. Delivery Year This is a number specifying the delivery year for this specific futures contract. As futures
contracts can often be purchased or traded more than a year in advance of delivery, this number is
important to distinguishwhich specific futures contract the investor is purchasing. (For example, an investor
would need to distinguish whether he was purchasing a rough rice futures contract for January 2009, or
January 2010 delivery.) Depending on the service used, this may be denoted either as a single digit (the
final digit of the four-digit year number) or two digits (the final two digits of the four-digit year number).
4. Exchange This convention is typically used external to the exchange on which the commodity is trading.
The grammar and abbreviation codes for the varying commodities exchanges are far less consistent than
the other elements of the ticker and should be checked by the user for whichever service she is
using. Wikinvest uses a trailing hyphen followed by the one or two-letter Thomson exchange code.
Traditionally, tickers are constructed by simply putting the components together (specific to the delivery date) to
create a three or four character ticker. Soybeans (S) with a November (X) 2009 delivery date
becomes SX9 while Lean Hogs (LH)with an April (J) 2010 delivery date becomes LHJ0. While this is the standard
denotation it assumes a universe internal to commodities and, as a result, in practice the way these elements are put
together to create a full ticker varies dramatically from service to service. (i.e. Financial services that cover both
stocks and commodities must alter this denotation to account for potential overlap in symbol.)
Yahoo! finance, for example, uses the convention "XXY##.ABC" where "XX" is the base symbol, "Y" the delivery
month, "##" is the delivery year (given in two digits) and "ABC" is the three-letter Yahoo! finance exchange code. For
example, wheat with a March, 2009 delivery, on Yahoo! finance, would be listed as: WH09.CBT
Wikinvest uses the convention "XX/Y#-AB" where "XX" is the base symbol, "Y" the delivery month, "#" is the delivery
year (given in one digit) and "AB" is the one or two-letter Thomson exchange code.
Monthly abbreviation codes for commodities futures ticker construction:
Month

January February March April May June July August September October November December

Ticker
F
Abbreviation

Examples

Lean Hogs futures are traded on the Chicago Mercantile Exchange (Thomson abbreviation "CM") under
ticker symbol LH with delivery dates in February, April, May, June, July, August, October, and December. The
Wikinvest ticker symbol for Lean Hogs with a May, 2009 delivery date would be: LH/K9-CM.

Corn futures are traded on the Chicago Board of Trade (Thomson abbreviation "CB") under ticker symbol C
with delivery dates in March, May, July, August, September, and December. The Wikinvest ticker symbol for Corn
with a September, 2009 delivery date would be: C/U9-CB.

Gold futures are traded on the COMEX, which is part of the New York Commodities Exchange (Thomson
abbreviation "NC") under ticker symbol GC with delivery dates in February, April, June, August, October, and
December. The Wikinvest ticker symbol for Gold with a December, 2009 delivery date would be: GC/Z9-NC.

A Forward Contract is a way for a buyer or a seller to lock in a purchasing or selling price for an asset, with the
transaction set to occur in the future. In essence, it is a financial contract obligating the buyer to buy, and the seller to
sell a given asset at a predetermined price and date in the future. No cash or assets are exchanged until expiry, or
the delivery date of the contract. On the delivery date, forward contracts can be settled by physical delivery of the
asset or cash settlement.
Forward contracts are very similar to futures contracts, except they are not marked to market, exchange traded, or
defined on standardized assets. Forward contracts trade over the counter (OTC), thus the terms of the deal can be
customized to fit the needs of both the buyer and the seller. However, this also means it is more difficult to reverse a
position, as the counterparty must agree to canceling the contract, or you must find a third party to take an offsetting
position in. This also increases credit risk for both parties.

What are the uses of forward contracts?

Forward contracts offer users the ability to lock in a purchase or sale price without incurring any direct cost. This
feature makes it attractive to many corporate treasurers, who can use forward contracts to lock in a profit margin, lock
in an interest rate, assist in cash planning, or ensure supply of a scarce resources. Speculators also use forward
contracts to make bets on price movements of the underlying asset derivative.
Many corporations and banks will use forward contracts to hedge price risk by eliminating uncertainty about prices.
For instance, coffee growers may enter into a forward contract with Starbucks (SBUX) to lock in their sale price of
coffee, reducing uncertainty about how much they will be able to make. Starbucks benefits from contract because it is
able to lock in their cost of purchasing coffee. Knowing what price it will have to pay for its supply of coffee ahead of
time helps Starbucks avoid price fluctuations and assists in planning.

How do forward contracts work?

Forward contracts have a buyer and a seller, who agree upon a price, quantity, and date in the future in which to
exchange an asset. On the delivery date, the buyer pays the seller the agreed upon price and receives the agreed
upon quantity of the asset.
If the contract is cash settledpot price, or price of the asset at expiry, is higher than the agreed upon Forward price. If
the spot price is lower than the Forward price at expiry, the seller has a cash gain and the buyer a cash loss. In cash
settled forward contracts, both parties agree to simply pay the profit or loss of the contract, rather than physically
exchanging the asset.
A quick example would help illustrate the mechanics of a cash settled forward contract. On January 1, 2009 Company
X agrees to buy from Company Y 100 pounds of coffee on April 1, 2009 at a price of $5.00 per pound. If on April 1,
2009 the spot price (also known as the market price) of coffee is greater than $5.00, at say $6.00 a pound, the buyer
has gained. Rather than having to pay $6.00 a pound for coffee, it only needs to pay $5.00. However, the buyer's
gain is the seller's loss. The seller must now sell 100 pounds of coffee at only $5.00 per pound when it could sell it in
the open market for $6.00 per pound. Rather than the buyer giving the seller $500 for 100 pounds of coffee as he
would for physical delivery, the seller simply pays the buyer $100. The $100 is the cash difference between the
agreed upon price and the current spot price, or ($6.00-$5.00)*100.