Page 49 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes Also, since the contracts are not exchange-traded, there is no marking to market
requirement, which allows a buyer to avoid almost all capital outflows initially (though
some counterparties might set collateral requirements).
Given the lack of standardisation in these contracts, there is very little scope for a secondary
market in forwards.

The price specified in a forward contract for a specific commodity.
The forward price makes the forward contract have no value when the contract is written.
The forward market is like a real estate market in that any two consenting adults can form
contracts against each other.
This often makes them design terms of the deal which are very convenient in that specific
situation, but makes the contracts non-tradable.

3.5 Keywords

Delivery Price: The pre-specified price of the underlying assets at which the forward contract is
settled on expiration is said to be delivery price.
Economic exposure: Economic exposure refers to the impact of fluctuations in financial prices on
the core business of the firm.
Forward Contract: A forward contract is one to one bi-partite contract, to be performed in the
future, at the terms decided today. (E.g. forward currency market in India).
Future Spot Price: This is the spot price of the underlying asset on the date the forward contract
expires and it depends on the market condition prevailing at the expiration date.
Long Position: The party that agrees to buy an underlying asset (e.g. stock, commodity, stock
index, etc.) in a future date is said to have a long position.

Short Position: The party that agrees to sell an underlying asset (e.g. stock, commodity, indices,
etc.) in future date is said to have a short position.
Transactional risks: Transactional risks reflect the pejorative impact of fluctuations in financial
prices on the cash flows that come from purchases or sales.
Transferable Specific Delivery (TSD) contracts: These are contracts, which, though freely
transferable from one party to another, are concerned with a specific and predetermined
consignment or variety of the commodity.
Translation risks: Translation risks describe the changes in the value of a foreign asset due to
changes in financial prices, such as the foreign exchange rate.

3.6 Review Questions

1. What do you mean by a Forward Contract? Explain using a suitable example.
2. Define the concept forward contract and explain its features.
3. “Forward contracts act as fore-runners of futures market”. Critically evaluate the statement
in the light of growth of forward market worldwide.
4. Write a detailed note on classification of forward contracts with examples.
5. Briefly discuss the trading mechanism of the forward market.

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