What are forward contracts with explanation

Forward Contracts : Stock Market : NCFM Course in Hyderabad

AS Chakravarthy Stock Market Course in Hyderabad: Forward Contracts

Stock Market : NCFM Course in Hyderabad  Ameerpet

A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges.

The salient features of forward contracts are as given below:

  • They are bilateral contracts and hence exposed to counter-party risk.
  • Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality.
  • The contract price is generally not available in public domain.
  • On the expiration date, the contract has to be settled by delivery of the asset.
  • If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged.

Limitations of forward markets

 Forward markets world-wide are posed by several problems:

  • Lack of centralization of trading,
  • Illiquidity and
  • Counter party risk

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Source: www.nseindia.com

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