ExpertDabbler

FORWARD CONTRACTS

this time i am back with some useful info on the financial markets.no i dont mean to provide any tips on the stocks to buy.. but it will be about the terms which we come across in financial newspapers and about which we wish we knew somethig abt.

ok lets take FORWARD CONTRACTS…

FORWARD CONTRACTS are nothing but transactions where the actual settlement happens on a future date. sounds latin eh?
ok now supose u want to buy a cot.u go to the furniture shop, enquire, select yr favourite model, fix the price. Now is the hitch. lets assume u dont have enough money on hand right now, and u dont want to get it on credit either ( like me). and u dont want to postpone it further cos the price may rise in due course of time.
what do u do?
u enter into an agreement with the shop keeper wherein u agree to get the cot @ 300 bucks on Dec 15.
the rate is fixed.on that day u will pay the shopkeeper.
now what is the deal? well both of u ( yrself and the seller) don’t have any idea about the probable price of the cot on Dec 15. if its going to go down to say 250, then the seller has made a profit. By entering into a contract with you. he has effectively sold a cot which is worth 250 on that date to u @ 300.
now suppose if the price goes up to 350 on that date - obviously then u’d made a profit. u’d bought a cot worth 350 for 300.
this is a simple example for forward contracts.

ok, the real significance comes into the picture when u consider that you are not in the business of buying and selling cots and u were prepared to get the cot at 300 anyway.

u had effectivley covered the risk of the price of the cot getting higher than what u had initally prepared for when u entered the contract. in other words u have effectively hedged your RISK

now for cots try to imagine oil requirements for a big nation like India?

what will happen if the price of the dollar fluctuates a few cents more than we could afford to?
Either we should reduce the oil intake - which is not feasible or we may need to shell out the extra amount somehow.
Suppose we can enter into a forward contract with Saudi Arabia we effectively fix the costs involved and cover the risk of it going beyond our comfort levels.
so a forward contract can be on anything..entered into by any two parties and transacted anywhere. infact this has happened since time immemorial..
next we shall see abt futures.. FORWARDs younger sibling. till then BREAK:-))

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