A Forward is a derivative financial instrument, an agreement between two participants, according to which the seller undertakes to deliver, and the buyer - to pay and receive a certain amount of the underlying asset in the future at a price determined at the time of the transaction. Unlike futures, a forward is not an exchange contract. It is concluded for any period by agreement by the parties. The volume of the proposed deliveries is also regulated only by mutual agreement. Forwards are most often concluded between banks. Forward contracts tend to be currencies and interest rates.
The following conditions must be fixed in the forward contract:
• the amount of the contract;
• forward price;
• forward date;
• methodology for calculating the benchmark price.
There are two types of forward contracts: settlement and delivery.
A Settlement forward contract ends with mutual settlements between the parties to the transaction, rather than the delivery of the underlying asset. Settlement terms are determined by the difference in the benchmark price, for example, the Central Bank rate on the day of the contract execution, and the forward price fixed at the conclusion of the contract.
If the reference price is higher than the forward price, then the buyer will receive a profit in the amount of:
(Reference Price - Forward Price) * Contract Volume
The seller, in his turn, will receive a loss in the amount of:
(Forward Price - Reference Price) * Contract Volume
If the reference price turns out to be lower than the forward price, on the contrary, the buyer will receive a loss, and the seller - a profit.
A delivery forward contract is the right and obligation for one party of the contract to buy, and for the other party, the right and obligation to sell the underlying asset enshrined in the contract at a certain price, in a certain amount, at a certain point in the future.
If the market price at the time of implementation of the deliverable forward contract is higher than that fixed in the contract, the buyer will receive a profit in the amount of:
(Market Spot Rate - Forward Price) * Contract Volume
The seller will make a loss in the amount of:
(Forward price - Spot rate on the market) * Contract volume
Types of forward contracts:
• Currency. A foreign exchange forward contract is an agreement that allows the parties of the transaction to fix the exchange rate for the conversion of a currency pair in the future. In the case of a settlement currency forward, only the party of the transaction which has suffered the loss makes the payment.
• Interest. An interest rate forward contract is primarily used for hedging purposes. It is an agreement on the terms of attracting or placing funds, which will be executed at a certain point in the future. This type of forward contract includes, among other things, agreements such as: FRA (Forward Rate Agreement), ERA (Exchange Rate Agreement), FXA (Forward Exchange Agreement).
• Commodity. A commodity forward contract means fixing the terms of delivery of goods at a certain time in the future, at a predetermined price and in a certain quantity.
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