1.3 FORWARD CONTRACTS

A relatively simple derivative is a forward contract. It is an agreement to buy or sell an asset at a certain future time for a certain price. It can be contrasted with a spot contract, which is an agreement to buy or sell an asset almost immediately. A forward contract is traded in the over-the-counter market—usually between two financial institutions or between a financial institution and one of its clients.

One of the parties to a forward 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.

Forward contracts on foreign exchange ...

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