FORWARD CONTRACT

Meaning : A forward contract is a simple customised contract between to parties to buy or sell an asset at a certain time in future for a certain price agreed today. Forward contracts are over-the-counter traded contracts, means they are not traded in stock exchange. these contracts are generally private contracts between two financial institution or between a financial institution and its corporate client.

Over-the-counter market is a market where sell and purchase of securities and commodities are undertaken between two parties at some specific place through dealers network and not through stock exchange. over-the-counter market is also known as off-trade exchange.

In forward contract one party takes long position and other party takes short position.

Long Position – When a party agrees to buy the asset at a certain specified date for a specified price, it is said to have taken a long position.

Short Position – The other party which agrees to sell the asset on the same date for the same price is known to have taken Short position.

Features of forward contract –

  1. they are bilateral contract where all details of the contract are negotiated by the parties bilaterally
  2.  it is highly customised contract where each contract is unique in terms of contract size, expiration date, and the asset type and quality.
  3. it is traded over-the-counter and not through stock exchange.
  4. the settlement takes place through delivery of the asset on the expiry date.
  5. it tries to mitigate the price risk but does not eliminate performance risk.
  6. in forward contract, sometime derivative can be contracted for a combination of underlying assets properly known as synthetic assets.
  7. forward contracts are more popular in foreign exchange and usually have foreign desk to perform such type of contract.
  8. in forward contract there is higher chances of counter party risk, which is a serious issue worldwide.