Page 39 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives Rupesh Roshan Singh, Lovely Professional University

Notes Unit 3: Introduction to Forward Contracts

CONTENTS
Objectives
Introduction

3.1 Forward Contracts
3.1.1 Definitions
3.1.2 Features of a Forward Contract
3.1.3 Classification of Forward Contracts
3.1.4 Forward Contract Mechanism
3.2 Forward Terminologies
3.3 Benefits and Limitations of Forward Markets
3.4 Summary
3.5 Keywords
3.6 Review Questions
3.7 Further Readings

Objectives

After studying this unit, you should be able to:
 State the definition and concept of forward contracts;
 Describe the terminologies used in forward contracts;
 Discuss the salient features of forward contracts;
 Discuss the classification of Forward Contracts;
 Explain the benefits and limitations of Forward Markets.

Introduction

In the previous unit, we studied about the derivatives market in India i.e. derivatives market at
NSE, BSE, NIFTY and SENSEX. We also discussed about the important eligibility/regulatory
conditions specified by SEBI, comparison between NSE and BSE, Index derivatives and Exchange
Traded Funds in the last unit. This unit will helps you to understand the concept of forward
contracts and the terminologies used in it. We will also learn the various features, classification,
benefits and limitations of forward contracts in the various sections and sub section of this unit.
To make the learning easier, we will take the help of globally recognised best practices.
A Forward Contract is a contract made today for delivery of an asset at a pre-specified time in
the future at a price agreed upon today. The buyer of a forward contract agrees to take delivery
of an underlying asset at a future time (T), at a price agreed upon today. No money changes
hands until time T. The seller agrees to deliver the underlying asset at a future time T, at a price
agreed upon today. Again, no money changes hands until time T. A forward contract, therefore,
simply amounts to setting a price today for a trade that will occur in the future. In other words,
a forward contract is a contract between two parties who agree to buy/sell a specified quantity
of a financial instrument/commodity at a certain price at a certain date in future.

34 LOVELY PROFESSIONAL UNIVERSITY