A forward contract is an agreement between two parties to buy or sell an underlying asset at a pre-specified price on a pre-specified date in the future. The assets underlying a forward contract could be anything, such as a commodity (gold, oil, cotton, etc.), or financial instruments (equity, T-bills, currencies, etc.). Forward contracts are private […]
Forward Markets and Contracts
Forward Contracts – Settlement/Default Risk (T-bill Example)
We learned that a forward contract is a contract between two parties to buy/sell an underlying asset at a specified price on a specified date. In this contract, the party that agrees to buy the underlying asset has a long forward position and the party that agrees to sell the underlying asset has a short […]
How is a Forward Contract Settled?
A forward contract can be settled in two ways: Delivery or Cash Settlement. In case of a deliverable forward contract, the party that is short the forward contract will actually deliver the underlying asset to the party that is long the forward contract. The underlying will be delivered on the settlement date or the expiration […]
Forward Contract Termination Prior to Expiry
In a forward contract, both parties are required to fulfill their obligation on the expiration date. Then what would happen if a counterparty wants to exit its position prior to expiration? The forward market does not have a provision of cancelling the contract. Instead, a party can terminate its position by entering into an opposite […]
End-user Vs. Dealers in a Forward Contract
People may use a forward contract for a variety of reasons, for example, a farmer may want to lock-in the price of its crop that will be available for sale after three months, or an importer may want to lock-in the exchange rate at which it will make the future payment for imports. These people […]
How Equity Forward Contracts Work?
An equity forward contract works in the same way as any other forward contract except that it has a stock, a portfolio of stocks or an equity index as the underling asset. It is an agreement between two parties to buy a pre-specified number of an equity stock (or a portfolio or stock index) at […]
Forward Contracts on Zero-coupon and Coupon Bonds
The forward contracts on bonds are similar to equity forward contracts except that they have bonds as the underlying asset. The forward contracts can be written on both zero-coupon bonds (such as T-bills in the US) and coupon paying bonds. Since bonds have a maturity date, the forward contracts on these bonds must also settle […]
How are LIBOR and EURIBOR Calculated?
The London Interbank Offered Rate (“LIBOR”) and the Euro Interbank Offered Rate (“EURIBOR”) are benchmark reference rates fundamental to the operation of both UK and international financial markets, including markets in interest rate derivatives contracts. LIBOR and EURIBOR are by far the most prevalent benchmark reference rates used in euro, US dollar and sterling over […]
Forward Rate Agreements and Calculating FRA Payments
Forward Rate Agreements (FRA’s) are similar to forward contracts where one party agrees to borrow or lend a certain amount of money at a fixed rate on a pre-specified future date. For example, two parties can enter into an agreement to borrow $1 million after 60 days for a period of 90 days, at say […]
How Currency Forward Contracts Work?
A currency forward contract is an agreement between two parties to exchange a certain amount of a currency for another currency at a fixed exchange rate on a fixed future date. By using a currency forward contract, the parties are able to effectively lock-in the exchange rate for a future transaction. The currency forward contracts […]