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What are Forward Contracts

In derivative market, one of important trade is forward trade. In forward trade, two or more parties contract each other on the basis of some terms. One party is the buyer and other party is the seller of financial or any other other product. In this contract, both payment and delivery of product is done in any future date. But price is fixed at current date. Such contract is called forward contract.


In simple words, this contract is the contract of commitment. Seller commits to deliver his product at future date and buyer commits to pay at future date. Price of product is fixed at current date. Now, both have some rights and obligations relating to this contract. This contract can be done for all products. Both financial and commodity products are included in it.

Compare Forward Contacts with Cash Contracts 

Cash Contract : You want to go to Kuwait. For this, you need dinar, you just go to bank and pay Rs. 108958.00 and buy 500 kuwaiti dinar, this is cash transaction and this is cash contract.

Forward Contract : You want to go kuwait at the end of 100th day. You just go to bank and contract for buying 500 kuwaiti dinar at the end of 100th day  with today rate. Today rate is 1 kuwaiti dinar is Rs. 217.92. There is no transaction between bank and you. This is just agreement. You are in the obligation to pay Rs. 108958 at the end of 100th day. Bank has obligation to deliver you the 500 kuwaiti dinar. If any party will refuse this, this will become breach of contract. Any party can go to court for safeguarding his rights.

More Deep Explanation with Beta Infographic




In above infographic, you have seen that both buyer and seller are agree to contract at $ 2 per unit of any product and after one year, buyer will buy and seller will sell. In this period, volatility will not change their commitments. If price at future date will rise, buyer will get less unit. It means, buyer is in profit by doing this forward deal. If price at future date will decrease, seller will give less. It means, seller is in profit by doing this deal. It is profit or loss situation for both parties. This contract must be bought by buyer for future date.

Remember Point : 

1st Situation :


=>>> Buyer is happy because he bought product at $ 2 through forward contract whose now price is $ 3

=>>> Seller is weeping because he sold his product at cheap rate of $ 2 but now its price is $ 3. He can earn one more dollar if he did not do forward contract. His luck is bad.

2nd Situation :

=>>>  Buyer is weeping because he bought his product at high rate of $ 2 but now its price is $ 1. He can earn one more dollar if he did not do forward contract. His luck is bad.

=>>>  Seller  is happy because he sold product at $ 2 through forward contract whose now price is $ 1.


Related : Currency Swap Examples 

COMMENTS

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  1. Great sir can you send compiled notes at carkjha@hotmail.com

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Accounting Education: What are Forward Contracts
What are Forward Contracts
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Accounting Education
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