O'Reilly logo

Derivatives Demystified: A Step-by-Step Guide to Forwards, Futures, Swaps and Options by Andrew M. Chisholm

Stay ahead with the world's most comprehensive technology and business learning platform.

With Safari, you learn the way you learn best. Get unlimited access to videos, live online training, learning paths, books, tutorials, and more.

Start Free Trial

No credit card required

Chapter 2. Equity and Currency Forwards

INTRODUCTION

A forward contract is an agreement made directly between two parties to buy and to sell a commodity or financial asset:

  • on a specific date in the future;

  • at a fixed price that is agreed at the outset between the two parties.

Forwards are bilateral over-the-counter (OTC) transactions, and at least one of the two parties concerned is normally a bank or some other financial institution. OTC transactions are used extensively by corporations, traders and investing institutions who are looking for a deal that is tailored to meet their specific requirements. Futures are similar in their economic effects but are standardized contracts traded on organized and regulated exchanges (see Chapters 4 and 5). Forwards involve counterparty risk – the risk that the other party to the deal may default on its contractual obligations.

Suppose that a trader agrees today to buy a share in one year's time at a fixed price of $100. This is a forward purchase of the share, also called a long forward position. The graph in Figure 2.1 shows the trader's potential profits and losses on the deal for a range of possible share values at the point of delivery. For example, if the share is worth $150 in one year's time, then the trader buys it through the forward contract and can sell it immediately, achieving a $50 profit. However, if the share is only worth $50 in one year's time, then the trader is still obliged to buy it for $100. The loss in that instance is $50. ...

With Safari, you learn the way you learn best. Get unlimited access to videos, live online training, learning paths, books, interactive tutorials, and more.

Start Free Trial

No credit card required