Basics of Forward Contract - Derivatives Market

Updated: Sep 16, 2020

#ForwardContract :

Forward contract is an agreement signed on X date and the maturity date is (X+Y) i.e. 1 week, 1 month, 3 months or, 6 months. A forward contract is an OTC (Over the Counter) product. This contract gives the right to underlying assets which both the parties would and thereto in the best of faith, not in compulsion. A forward contract is generally not a structured product and terms of contract are negotiated by both the parties.


#Exchange :

Exchange facilitates Over the Counter (OTC) contracts between two parties and own commission on execution of the contract. It also ensure that the contract is honored by charging margin to both the parties and remove opportunity cost.

E.g. - NCDEX, MCX



Margin :

Margin is the minimum amount to be paid by a party to sign a forward contract.


Contract Value :

It is a equal to product of number of lots signed between the two parties and the price at which contract is signed.


Lot Size :

Lot size ia a minimum quantity of an underlying asset for which a contract is signed.


Expiry Date :

It is a date on which the contract is to be executed. i.e. exchange of goods occur.



Example:


  1. ITC Company wants to purchase a wheat after 6 months for its floor mill. It fears that the price of wheat may increase after 6 months which may put pressure pressure on its margin.

  2. A farmer has about 1000 tons of wheat which he will get after 6 months during the harvest season. The farmer fears prices of wheat will go down.

  3. Both the farmer and ITC company enters into a forward contract for 6 months at current market price Rs 30 per kg.

  4. Contract Value = 30X1000X1000=3,00,00,000 (1 ton = 1000 kg)

  5. A farmer is tempted after 6 months to default on the contract if price of increases to Rs 35 per kg OR #ITC is incentives to dishonored the contract if the price of wheat fall to Rs 25 per kg.

  6. To avoid the either of these situation, both parties are require to pay a margin which nullifies the opportunity cost.


Thank You ...



628 views0 comments

Recent Posts

See All

Options Contract & Open Interest

American and European Options: The terms ‘American’ and ‘European’ refer to the type of underlying asset in an options contract and when it can be executed. American options’ are Options that can be e

mbanotes logo1.png
write us at : 
mbanotes.org@gmail.com

Follow us

  • Facebook

© 2020 by MBA Notes

www.mbanotes.org is an online portal which is one of its kind. It is a doorway beyond which lie all the answers for a student of The Master of Business Administration (MBA or M.B.A.) a master's degree in business administration, which attracts people from a wide range of academic disciplines. Whether you are a student of marketing, a fan of Phillip Kotler; or a person who is into the dynamics of managing people, the art of human resource; or a person who wants to be the next warren Buffett the master at making and managing money, we are here to serve everyone.

Keeping in mind the convenience of the visitors our efforts have been duly focused on making proper classifications. The idea is given shape by dividing the MBA curriculum into semesters and then into subjects so as to make sure that the students can get intended content in the least amount of time. We also allow and encourage students to share their own notes, projects, and presentations so as to give back to the community and help other students in their pursuit of knowledge.