The forward contract and its price
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Derivative financial instruments (derivatives) in recent years are very popular with investors as an attractive tool for speculative trading. On the other hand, they do not go with the first pages of the world's business media, because of their direct relevance to the scandalous losses and the collapse of some financial institutions. It may seem that the sale of the lot only sverhopytnyh professional traders largest financial services companies, but in practice it is not the case.
Forward contract - this is a binding agreement under which one party agrees to set the next day to deliver, and the other party to pay a certain amount of goods or financial asset at a predetermined price. The agreement itself does not mean the transfer of rights to the asset. From the transaction for immediate delivery and payment forward different future date of execution, hence the name of the whole class. Obviously, when it reached an agreement on the future of fixed price, each of the parties to a great extent based on the current price of the subject of the transaction, and in this sense the forward is a derivative transaction and the object of its underlying assets.
Forward contracts not necessarily conclude with the purpose of purchasing or selling the underlying asset. The purpose of these operations can be and making a profit on the price difference, at the same time, forward contracts, as if detached from the subject of the transaction, becoming self-reliant in financial instruments.
Thus emerged and entrenched expression "forward contract to buy" and "sell forward contract."
The minimum interval between the trade date and settlement date, at which the instrument is classified as "urgent", varies depending on the underlying asset. Typically, a "time-sensitive" operations are settled on the current date are separated by more than two days. The deal with the execution of the second working day shall be deemed concluded on spot conditions. In itself, the conclusion of the forward contract does not require any additional costs, but if the contract is with the help of a mediator, invoices and commission expenses may arise.
The main advantage of forward contracts is their individual character. With their help it is possible to form an arbitrary position with a maturity that allows you to minimize the risk as much as possible. In addition, in the case of the striker there is no need to take liquidity risk. The disadvantage of forward contracts, is the need for significant credit risk associated with the counterparty. In addition, OTC trades do not always have the ability to open or close a position on acceptable terms.
Forward contracts are widely used in trade with commodities. For example, a significant proportion of world cotton production is supplied by three and twelve-month forward contracts. And a country like Gunn, sells all made her cocoa beans through forward contracts. Colombia supplies almost the entire harvest coffee for processing on an annual forward contracts. However, perhaps the most famous and developed commodity forward markets are forward gold market and the forward market oil «Brent» mixture.
Forward Price - is the contract price, with all the terms of delivery, defined parties to the transaction on the basis of market supply and demand. Forward transaction is between the buyer and the seller, under the terms of their choice and can take place with the participation of a mediator ensures the execution of the contract for a fee.
Buyer forward conditionally open a long position, hoping for a rise in the price of the underlying asset. The seller of a forward contract, by contrast, won in the fall the price of the underlying asset to the specified date. That is, he will be able to sell the asset at a higher price than the market at the time of execution of the transaction.
Forward contracts are concluded between the parties in the OTC market. They usually involve the physical delivery of the goods and the characteristic of the commodity and currency markets.
In addition to forward contracts for the supply, there are the so-called forward contracts without delivery, payments which are made in cash without physical delivery of the goods. For example, buying a forward contract 16 June 2008 on the delivery of 100 ounces of gold for $ 900 with the date of execution of 20 July 2008, the buyer assumes the obligation to accept and pay for 90 000 dollars seller of this forward contract. In turn, the seller appears opposite obligation to deliver 100 troy ounces of gold at $ 900. Before any calculations indicated date and additional unspecified contract expenses, neither the buyer nor the seller does not arise. But as the price of the underlying asset, such as "gold", changes in the course of trading, the price of a forward contract for the supply of the same quantity of the underlying asset quality, and at the same date, will vary according to market conditions. In addition, the forward contract price depends on the price of the underlying asset in the spot market. If the actual market price on the settlement date is higher than the forward price, the buyer makes a profit, if the actual price is lower than the forward price, the profit received by the seller. Thus, forward contracts are used to insure the risks of adverse changes in the price of the underlying asset.
On forward markets, mainly work by institutional investors, producers and consumers of goods, whose main objective risk insurance.
Forward contracts are used exclusively in the OTC market. Secondary market of forward contracts for most of the assets is underdeveloped. An exception is the forward exchange market. Although prescribed in the contract penalties in case of failure of one of the parties of their obligations, the benefits of non-performance, even with their account may be so great that the counterparty in any case refuse to supply, so before the conclusion of the transaction, the partners should determine the solvency and the reputation of each other.
The ratio of forward and futures prices
Modern development of derivatives markets pose new challenges for investors. The question of the difference in prices of the futures and forward contract is quite important for professional stock market participants. Theoretical price of forwards and futures is calculated, in general, according to the same formula, but in practice should take into account the difference in the calculation of these contracts and other nuances that can affect the cost of the contract.
In general, the formula for the calculation - is the theoretical value of forwards and futures. This formula takes into account:
1. Firstly, the price of «Spot» of the underlying asset in the spot market at the present time.
2. In the second "T" is set during the life of the contract, ie, the number of days prior to the execution of a "T".
3. Third «R», takes into account the risk-free interest rate, the rate on short bonds, or other risk-free assets, on which you can place your money in the market with the guaranteed income at the date of the forward performance.
4. Also has a value of "income" in the ownership of assets. For example, dividends accruing to their owners during the life of the forward contract.
5. Finally, the price of the futures affect costs ( "Costs"). This payment for the storage of the underlying asset, such as oil, or other items in stock, for the entire period of his life forward.
Unlike forward, for the calculation of the theoretical futures price in the formula should be included in place of "the Spot" amount of free funds ( "BCA") necessary for the open futures positions on the futures market.
Thus, the problem of calculating the theoretical futures price should take into account the expectation of its future value after a certain time after its opening. It should be noted that the very value of futures, with a statement of the problem, will reflect market participants' expectations of the future price «Spot». Pricing futures simplified if urgent section of the exchange, it is possible adoption as collateral offered by futures contracts, risk-free instruments with a guaranteed income, such as bonds. In this case, the whole amount of the future transaction, by delivery of the underlying asset on the expiration date, it is possible simultaneously with the opening of the futures contract to buy the closest bond, which guarantees a fixed income for the period of ownership by contract.
There are other differences in the use of futures and forward contracts. For example, the payment of taxes. In futures accounted for a daily revaluation of positions, and all the calculations in forwards attributable to the final delivery date.
Quotations of futures contracts on all underlying assets traded in the financial markets, be sure to be published in the popular press. It complied with the rules of transparency and access to information for all market participants. For brief information using the settlement price for futures contracts, which is formed by the rules of the stock exchange and is a Futures on which the calculations are carried out on the basis of trading data.
Futures and options market today is of great interest to those who are looking for unconventional ways in augmenting their own savings, or income lungs. However, the work of a professional trader in the derivatives market, requires special qualities due to the speculative nature of this market…