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Unit 3: Forward Contracts
Rupesh Roshan Singh, Lovely Professional University

Unit 3: Forward Contracts Notes

CONTENTS
Objectives
Introduction
3.1 Basic Hedging Practices

3.1.1 Objectives of Hedging
3.1.2 Hedge Fund Strategies
3.2 Basics of Forward Contracts

3.2.1 Classification of Forward Contracts
3.2.2 Forward Contract Mechanism
3.2.3 Features of Forward Contracts
3.3 Limitations of Forward Markets
3.4 Summary

3.5 Keywords
3.6 Review Questions
3.7 Further Readings

Objectives

After studying this unit, you will be able to:
 Know the basic hedging practices
 Describe forward contracts
 Identify the limitations of forward market

Introduction

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.

3.1 Basic Hedging Practices

Corporations in which individual investors place their money have exposure to fluctuations in
all kinds of financial prices, as a natural by-product of their operations. Financial prices include
foreign exchange rates, interest rates, commodity prices and equity prices. The effect of changes
in these prices on reported earnings can be overwhelming. Often, you will hear companies say

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