In the 17th century, there was a period called the “Dutch Golden Age”. At the height of Tulip Mania, the contract price for bulbs of tulip reached such extraordinary prices that those prices did not reflect the actual value of the bulb of tulip.
Despite the high prices, there was a mad rush to sign contracts to buy bulbs of tulips When the bubble burst, many people lost their money.
In the California Fitness Saga, customers contracted to pay in advance for future services to be offered by the club. Unfortunately, that future turned out rather sour and people also lost their money.
In terms of risk, there is really no difference between the 2 types of contracts. They all share a common risk of entering into contracts and paying monies in the present time for a perceived future service.
In the case of Tulip Mania, it was the future of an increase in the price of the bulbs of tulips. In the case, of California Fitness it was a future promise to deliver fitness related services.
Like future price fluctuations, the market must accept there are risks attached to future delivery of services. That is why the customer gets a discount for assuming and contracting for that risk. Price fluctuation patterns are required to be disclosed to the public as such fluctuations have a major impact on the public’s decision. How does one disclose factors regarding the risky non-provision of future services?
The simple answer is corporate governance. Companies who value good corporate governance practices and keep good documentation generally indicate they are in good health and shape. But beware that good corporate governance goes beyond a popular brand. If you are required to look under complicated layers to discover the health of any company, that usually means they have things to hide.
Consult Us the next time you want to enter into any futures contracts with any company.