Financial Derivatives - Forward and Futures

Financial Derivatives - Forward and Futures free download

Forward & Future Contracts with Arbitrage and Hedging

In Financial World, the term derivative refers to contract which has no independent value but whose value is entirely derived from the value of the underlying asset.

Underlying assets can be securities, commodities, currency, shares etc.

Financial Derivatives are mainly bifurcated into forwards, futures, options and swaps.

In this series, we will mainly learn about forwards and futures.

Forward Contracts and Future Contracts:

Forward contract is a contract between two parties where one party agrees to buy let say share of the company and other party agrees to sell the same share at a fixed time in future for a price determined in advance between two parties.

Future contract is special type of forward contract where fixed number of contracts to be entered. Let us say minimum 10 shares to be bought and sold).

Features of forward contract & future Contracts:

1. Forward contract are contract between 2 parties and hence there is risk of non-performance of obligation by either of the party. Such risk is not there in future contracts as they are standardized by exchanges.

2. Each contract is designed between 2 parties and hence they are unique in terms of asset type, quantity, Contract size, expiration date etc.

3. In forward contract, one party agrees to buy (Long in finance terms) an asset and other party agrees to sell (Short in finance terms) the same asset at the same date for same specified price. In future contract same thing happens only thing is that contracts need to be entered into lot of quantities as discussed above.

4. In forward market, the contract has to be settled by delivery of the asset on expiration date however in future contracts they are cash settled.

5. In forward contract initial money is not required to enter the contract commonly called as margin money but same is required for future contracts.

6. Forward contracts are settled on expiry while future contracts are daily settled.

So Lets learn how risk less profits can be earned through forward and future contracts. Also we can learn how it can be used as hedging tool.