DR.

IT GROUP OF INSTITUTES

BY:GUNEET SINGH KANIKA DILJEET SINGH SANDEEP KUMAR KUNDAN SANJAY

Forward Contracts
A forward contract is an agreement between two

parties for the delivery of a physical asset (e.g., oil or gold) at a certain time in the future for a certain price that is fixed at the inception of the contract.
Forward contracts involves no money transaction at

the time of signing the deal.

Forward Contract governed by the Forward Contract

(Regulation) Act, 1952

2

Example:On June1, X enters into an agreement to buy 50 Quintals of cotton on December 1 at Rs. 1000 /-per Quintal from Y , a cotton dealer. It is a case of a Forward Contract where X has to pay Rs. 50,000 on December 1 to Y and Y has to supply 50 Quintals of cotton.

Future Contracts
Futures contracts is an agreement between two parties

to buy or sell an asset at a certain time in the future at a certain price. Future Contracts are special types of Forward Contracts as they are standardized exchange-traded contracts.

Features of Forward Contracts :1.

2. 3.

4.
5. 6. 7.

Over the counter trading(OTC) No down payment Settlement at Maturity Linearity No Secondary Market Necessity of a Third Party Delivery

Financial Forward:Forward rate contracts for commodities are commonly found in India. But, the use of this instrument in the financial market is a new phenomenon. The popular type of financial forward rate contract is the forward rate currency contract.

Forward Rate Currency Contract

It is a contract where exchange of currencies is promised at an agreed exchange rate at a specified future date. The important feature of this contract is:The payoff is proportional to the difference between the rate specified in the Forward Rate Contract and the price of currency prevailing in the market at the time of settlement.

Example:Position of net payoff to the holder of a Forward Rate Contract

Types of Forward Contract

Forward contract governed by the Forward Contract (Regulation) Act, 1952
Hedge Contracts: Transferable Specific Delivery Forward Contracts:

Non-Transferable Specific Delivery Forward Contracts:

Other Forward Contracts:-

i). Forward Rate Agreements (FRA) ii). Range Forwards

Comparison Future and Forwards Contract

Basis Future Contract Forward Contract Nature of Contract Future contract are highly standardized Forward contract is personalized and unique.

Settlement

Future are settled at the end on the last trading date of the contract with the settlement price.

Forwards are settlement at the start with a forward price.

Realization of P/L

The P&L on a futures position is The P & L is realised only at the exchanged in cash everyday. time of settlement so the credit exposure can keep increasing It does not specify to whom the It is clearly specified who delivery of a physical asset must receives the delivery. be made. Future are traded on an exchange . Exchange provides the mechanism that gives the two parties a guarantee that the contract will be honoured. Forwards are traded over-thecounter. There is no surety/guarantee of the trade settlement in case of forward contract.

Delivery Specification

Intermediary

Guarantee

Forward Contract on Interest Rate:The extension of the forwards to the interest is an important innovation. This type of contract is called Forward Rate Agreement(FRA). It is a contract where parties enter into a forward interest rate agreement at a specified future date.

Example:A financial intermediary expects a good demand for funds after 4 months. So, he enters into a Forward Rate Agreement after 4 months at a specified interest rate. After 4 months, he has to pay or receive the difference b/n the FRA interest rate and the market interest rate. As a result, his net payment of interest on the funds borrowed after 4 months will be equal to the FRA rate only.

Forward Rate Agreements

Promises interest rate on future loan.

( L R) D A FRA ( B 100 ) L D

Determination of forward prices

At the expiry the value of forward contract to buy a commodity:(Commodity price forward price)

Contract forward rate

Long commodity forward

Profit 0

Commodity Price

At expiry the value of forward contract to sell commodity :-

Forward price Commodity price

+
Short commodity Spot

k Profit 0
Commodity Price

Swap rate

Short commodity Spot

Long commodity forward

Spot rate

Forward rate Commodity Price

Profit 0

Swap rate = Spot Price Forward rate

Relationship between Forward price and Current Commodity Price

Current commodities Price = Forward Price/ (1 +y)t where Y =yield to mature for a risk free bond with a maturity equal to the term of forward contract, t Forward Price = current commodity price * (1+y)
t

Problem with Forwards: Default

Farmer and warehouse must check each others credit

worthiness
Forward contracts are inherently credit instruments. Only people with good credit can use them.

Margin and Daily Settlement

Margin

A good-faith deposit (or performance bond) made by a prospective trader with a broker. Margin can be posted in cash, bank letter of credit or short-term U.S. Treasury instruments. Daily Settlement Process by which traders are required to realize any losses in cash immediately (marked-to-the-market). The losses are usually deducted from the margin deposit.

TYPES OF MARGIN: There are 3 types of margin: 1. Initial Margin

Deposit that a trader must make before trading any futures.

2. Maintenance Margin

When margin reaches a minimum maintenance level, the trader is required to bring the margin back to its initial level. The maintenance margin is generally about 75% of the initial margin.
3. Variation Margin

Additional margin required to bring an account up to the required level.

CONCLUSIONS: Forward

share transaction, should be through an agreement/undertaking to sell or purchase at a future date and it should not be a sale and purchase agreements.

If at the agreed time the party does not perform, the(seller)

can recover the differential to compensate the loss suffered by him due to depreciation of the price and adjust the earnest money there against.