Forwards

Forwards

1. Is a non-standardised derivative contract in which one of the parties is usually a financial institution, to buy or sell an asset at an agreed price on a specific future date.

2. Type of assets: * Foreign Currency * Government Bond * Commodities (crude oil, agricultural products and metals)

3. RISKS:

   • CREDIT RISK: If one party defaults the other party suffers loss
   • MARKET LIQUIDITY RISK: The two parties can't sell the contract to a third party
   • SETTLEMENT RISK: One party defaults on settlement of payment

4. Trading Process: Recommended to get two quotes / FEC = credit with the bank just simply contact the bank. No money change hands until settlement date

   • REAL EXPOSURE = No Up Front Costs

5. Interest Rates Forwards: The difference in interest cost between the agreed rate and the current rate at the future date is settled in cash, at the start of the reference period

   • Eg: FRA (Forward Rate Agreement

6. Forward price of Commodities: Depending on the type of asset - Agricultural can't be held for long time

   • CONTANGO: Forward price exceeds the current spot price. This is normal for a non-perishable commodity that has a cost to carry
   • BACKWARDATION: Forward price of a commodity is lower than the current spot price. Harvest/natural disasters can affect price

7. FUTURES Vs FORWARDS: Both used for Hedging, Speculation and Arbitrage

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