Forward Market And Contracts

DerivativesAlaleh Mani2013

Introduction

Forward is a Highly Customized bilateral contract of obligation to sell(short) and buy (long)physical asset at a specific price in the future.

No cash flows at the initiation . Exposed to default risk. (Counterpart risk) No regulatory control over these contracts. Entire profit or loss gets accumulated till the

settlement date. Held till expiration. No active secondary Low liquidity. In order to Speculation on the future price In order to hedge a risk

Terminating the Position Entering to a new identical contract to lock in a

minimum loss. If the counterpart of the new contract is

different with the first one, the probability of credit risk would be high.

Both Forward and Future considered leveraged instruments because for little or no cash outlay

Cash Settlement= price movements in the underlying asset

Deliverable Forward Contract= Deliver, hold or warehouse the actual asset.

Dealers Compensation Banks or securities broker Bid and ask spread is for:1. Compensation2. Bearing default risk3. Asset price risk

Equity forward contracts

Underlying asset=Single Stock, Portfolio of stock, Stock Index

Portfolio Forward Contract has a better pricing compare to single stock forward contract due to less administration cost

Stock Index forward contract is based on a notional amount like cash settlement contract.

The contract should be set for a rime before maturity date of the bond.

Eurodollar Deposit=deposit dollar in big Banks out of US

LIBOR=London Inter Bank Offered Rate

Euribor established by Euro Central Bank at Toronto

Forward Contract on Zero Coupon and Bond

FRA and Currency forward contractA cash settlement contract on (lending /borrowing) money

(Notional Principal)(Floating-Forward)(days/360) = Pa y m e n t s

1+[(floating)(days/360)]

Currency forward Contract = one party agrees to exchange a certain amount of one currency for a certain amount of another currency at a specify exchange rate.