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what is forward contract.

                     Forward contract 


derivative contract , forward contract.
Forward contract.

Forward contract is an agreement made directly between two parties to buy or sell an  asset on a specific date in the future, at the terms decided today. Forwards are widely  used in commodities, foreign exchange, equity and interest rate markets.

  Let us understand with the help of an example.

  Assume on May 9, 2020 you wanted to purchase gold  from a goldsmith. The market price for gold on May 9, 2020 was Rs. 30,425 for 10  gram and goldsmith agrees to sell you gold at market price. You paid him Rs. 30,425 for  10 gram of gold and took gold. This is a cash market transaction at a price (in this case  Rs. 30,425) referred to as spot price.  Now suppose you do not want to buy gold on May 9, 2020, but only after 1 month.  Goldsmith quotes you Rs. 30,450 for 10 grams of gold. You agree to the forward price  for 10 grams of gold and go away. Here, in this example, you have bought forward or  you are long forward, whereas the goldsmith has sold forwards or short forwards. 



 There  is no exchange of money or gold at this point of time. After 1 month, you come back to  the goldsmith pay him Rs. 30,450 and collect your gold. This is a forward, where both  the parties are obliged to go through with the contract irrespective of the value of the  underlying asset (in this case gold) at the point of delivery.   

It is a contract between two parties .  All terms of the contract like price, quantity and quality of underlying, delivery  terms like place, settlement procedure etc. are fixed on the day of entering into  the contract.  In other words, Forwards are bilateral over‐the‐counter (OTC) transactions where the  terms of the contract, such as price, quantity, quality, time and place are negotiated  between two parties to the contract. Any alteration in the terms of the contract is  possible if both parties agree to it. Corporations, traders and investing institutions  extensively use OTC transactions to meet their specific requirements. The essential idea  of entering into a forward is to fix the price and thereby avoid the price risk. Thus, by  entering  into  forwards,  one  is  assured  of  the  price  at  which  one  can  buy/sell  an  underlying asset. 
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The analogy I have used might not be 100% correct but it’s easy to understand things with a simpler analogy.

That’s it for this post. Do check out my other posts to gain more knowledge about finance.

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Location: Pune, Maharashtra, India

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