Product service forward contract. Currency forwards
forward contract (forward) is an agreement according to which one party to the transaction - the seller undertakes, within the period specified in the agreement, to transfer the underlying asset (goods) to the other party under the agreement - the buyer or to perform an alternative monetary obligation.
At the same time, the buyer undertakes to accept and pay for this underlying asset, under the terms of which the parties have counter monetary obligations in the amount depending on the value of the underlying asset indicator at the time of fulfillment of obligations, in the manner and within the period or within the period established by the agreement.
In other words, a forward contract is a bilateral agreement on the sale (acquisition) of the underlying asset, which is drawn up according to standard form. A forward contract certifies the fact that one party at a certain time undertakes to sell or acquire an asset under specified conditions. At the same time, the price of the transaction, which will take place in the future, is fixed and set at the time of the conclusion of the forward contract.
Thus, a forward contract is a binding futures contract, in accordance with which the buyer and seller agree to the delivery of goods of a specified quality and quantity or currency on a certain date in the future.
The price of the product, exchange rate and other conditions are fixed at the time of the conclusion of the transaction.
What should be included in forward contracts
Forward contracts should include the following:
Subject of contract. The subject of the transaction is a realizable asset. It can be both a real product and a financial instrument (for example, an interest rate);
The quantity of the asset to be delivered. The quantity should be indicated in units convenient for the client;
Delivery date of the asset. The delivery date of the asset is fixed and cannot be changed;
Delivery (execution) price - the amount that the buyer of the asset pays to the seller (fixed in the terms of the contract, cannot be changed);
The forward price is the same delivery price, but not fixed, but determined at a specific time moment. The forward price of an asset is the current price of forward contracts for the underlying asset. The price of the asset is set at the time of the forward contract. Settlements between the parties to the transaction under the forward contract are carried out at this price.
The main features of a forward contract
The main features of a forward contract are as follows:
a forward is concluded outside the exchange, in contrast to a similar agreement - a futures contract;
term forward contract can be anything that the parties agree on;
there is no strict standard for forward transactions, unlike futures;
forward contracts are not required to report;
the forward cannot be broken or altered by either side;
have a free form regarding the expression of the will of clients;
forward is not retroactive;
the parties do not bear the cost of concluding a forward contract.
Advantages and disadvantages of forward contracts
The main advantage of these contracts is the fixation of the transaction price for a future date. And forward transactions do not provide for the attraction of additional funds. The main disadvantage is that if the price changes by the settlement day in any direction, the counterparties cannot terminate the contract.
That is, the main disadvantage of a forward contract is the lack of room for maneuver. After all, the obligation of the parties to fulfill their part of the agreement does not give an opportunity to terminate the forward contract before the set date or, in any way, change the main terms of the transaction.
Due to the lack of a secondary forward market, it is not possible to resell the forward contract. This, in turn, leads to low liquidity of the forward in the presence of a very high indicator of the risk of default by one of the parties to the transaction of its obligations.
Distinctive features of forward contracts
Distinctive features are that:
forward contracts are binding;
the agreement is drawn up taking into account the specific requirements of the transaction participant;
during negotiations at the stage of concluding a forward contract, the following should be clearly defined: the size of the contract, quality characteristics of the asset to be delivered, the place and date of delivery.
Types of forward contracts
Forward contracts can be:
delivery;
non-deliverable (settlement);
currency.
The delivery forward ends with the delivery of the underlying asset and full payment on the terms of the contract (transaction). A non-deliverable (settled) forward does not result in the delivery of the underlying asset. In a currency forward, the parties exchange currencies, the exchange rate of which remains unchanged.
Forward contracts by type of underlying asset
According to the type of underlying asset, forwards can be divided into two groups: commodity financial.
Commodity forwards
Commodity forwards refer to tangible items of sale, such as:
-
products Agriculture etc.
energetic resources;
Financial forwards
Financial forwards are an underlying asset that represents the following financial instruments:
-
interest rates;
-
other securities and stock values.
Forward contracts by parties to a forward transaction
If we take into account the parties to the contracts, we can distinguish:
forwards between banking organizations or between the bank and the client;
forwards between trading and manufacturing enterprises.
Forward hedging
Hedging is a mechanism for reducing contractual risks.
The purpose of hedging is to minimize possible losses due to market price fluctuations.
In practice economic activity It is customary to hedge the following types of risks:
currency, resulting from fluctuations in exchange rates;
percentage, the reason for which lies in the change in quotes valuable papers;
commodity, associated with price dynamics, inflation, and other economic factors.
Still have questions about accounting and taxes? Ask them on the accounting forum.
Forward (forward contract): details for an accountant
- Currency risk management: existing tools
Due to the lack of exchange commission. Forward contracts are always quite convenient: you can fix...
- The procedure for accounting for business transactions related to the execution of a forward contract for the purchase of currency
Accounting business transactions under forward contracts is not regulated, the organization can independently ... in international practice accounting forward contracts are treated as financial derivatives... if the entity has entered into a deliverable forward contract. A non-deliverable forward contract is originally FISS and... tax accounting forward contracts. one. Accounting policy For tax purposes, a forward contract is classified as...
-
Larionova, Chief Accountant PKF FORWARD LLC (IFTS No. 6 in Moscow...
- News of tax inspections of Moscow and Moscow region
Larionova, chief accountant of PKF FORWARD LLC (IFTS No. 10 for Moscow...
- News of tax inspections of Moscow and the Moscow region
Larionova, chief accountant of PKF FORWARD LLC (IFTS No. 10 for Moscow...
- Recognize the character of the future boss at the interview
Larionova, chief accountant of PKF FORWARD LLC: - Oddly enough, it should be alarming ...
- Features of determining certain types of income
Futures instruments (futures, options, forwards, etc.) are taxable...
- Transition to IFRS/IFRS 9 Financial Instruments
Embedded in a convertible bond; Forward contracts to sell currencies embedded in... embedded in a convertible bond; Forward contracts to buy currency embedded in... on predetermined terms; forward contracts that establish obligations for two ... combined financial assets (for example, forward contracts to sell currencies embedded in ... combined financial obligations(for example, forward contracts to buy currency embedded in...
- Consolidated statement of cash flows in IFRS
...); cash receipts on futures, forwards, options and swaps; cash payments on futures, forwards, options and swaps...
- Accounting for an entity's acquisition of futures
Including futures, options, forward contracts. They also include agreements...
- Clarified the procedure for filling out a notice of controlled transactions in relation to certain types of transactions
In particular, for an OTC settlement forward transaction, a sale (disposal) transaction of bonds... Notifications for an OTC settlement forward transaction and a sale (disposal) transaction ... filling in the Notices for an OTC settlement forward. In accordance with the Filling Order... agreed by the parties. In the settlement forward, the amount Money defined as... For example, "OTC settlement forward. USD/RUB sale. Amount 5000 ... the number of pieces (units) of the forward underlying asset, for example "500000" ...
The organization is a party to a futures transaction (forward, futures, option, swap, etc.)
forward transaction – This is a type of transaction in which one of the parties undertakes to sell a certain amount to the other party foreign exchange at a predetermined time at a specific rate. In this case, the course will be indicated in the agreement..
Thanks to forward transactions, you can buy and sell currencies in the future without worrying about possible price fluctuations. This opens up great opportunities for businessmen to manage risks, and allows them not to worry about unforeseen changes in the exchange rate. national currency.
Consider an example of a real forward transaction:
A large Russian plant plans to conclude a contract with foreign suppliers for the purchase of raw materials with a total value of $ 300,000, which must be paid in 3 months. The management of the plant came to the conclusion that the conditions are quite acceptable. So, taking into account the current dollar exchange rate - 59r. - in 3 months, 17 million 700 thousand rubles must be paid. But what will happen if the ruble suddenly falls, say, to 65 rubles. for 1 dollar? Obviously, nothing good for the plant, because the contract amount will already be 19 million 500 thousand rubles. This is where a forward contract comes in handy. Let's say the broker provides a leverage of 1:50 and the factory is required to deposit something like a deposit of 10% (this is the maximum) from total amount contract - thus, buyers guarantee for themselves the purchase of raw materials at a fixed exchange rate.
Forward transactions are great for international companies because they protect against unexpected monetary losses. But in last years there is a growing number of private investors who use this type of contracts in order to protect themselves during large foreign purchases, such as real estate, or, if necessary, pay for training, long business trips, etc. And increasingly, this tool is used by traders on financial markets for the purpose of making a profit.
The main advantage of working with a currency forward, as opposed to trading currency pairs, is the absence of swaps. A great option for long-term trades, because you do not have to pay for daily position rollovers. Given the duration of the transaction for several months - significant savings trader's deposit!
Best forex brokers
Alpari is the undisputed leader in the forex market today best broker for traders from Russia and CIS countries. The main advantage of the broker is reliability, confirmed by 17 years of work. Alpari gives traders the opportunity to earn and withdraw profits.
Roboforex is an international broker of the highest level with CySEC and IFCS licenses. On the market since 2009. Provides a range of innovative tools and platforms for both traders and investors. It is famous for its excellent bonus program which includes free $30 for beginners.
Specific features of currency forwards:
- non-negotiable and binding contract;
- the parties must agree on the size, time and place of delivery, the quality of the asset is specified, and other requirements of the parties are taken into account;
- this contract is not subject to mandatory reporting;
- the main advantage is a clearly fixed price for a specific date;
- as the main drawback - regardless of the value of the price, none of the parties will be able to refuse to fulfill the contract.
Forward transactions are classified as futures. The same category includes:
d) various combinations of the above transactions.
Consider another example of a EUR/RUR forward contract
The firm plans to purchase imported goods in 2 months. Of course, this requires a currency. In order to reduce risks, the company resorts to hedging and enters into a forward contract for the euro for 2 months.
The price of the contract on the date of its completion will be calculated at the following rate: 69 rubles for 1 EUR. But, in the foreign exchange market, the exchange rate is constantly changing, and after 2 months the ruble fell to 72 rubles per 1 euro. But our trading company will still receive the required amount at the rate of 69 rubles. To do this, you need to transfer a deposit to your broker.
What is the difference between a futures contract and a forward contract
A futures contract is a fairly standard contract between two entities. One of them undertakes to deliver the underlying asset at the agreed date and time, and the other undertakes to buy. Futures refers to exchange-traded instruments, it is traded on the exchange, and the rules for conducting such transactions are regulated by the rules of the exchange.
Some other differences between forwards and futures:
- a forward transaction allows the parties to independently determine the volume of supply, with futures, the volume of the contract is set by the exchange, and the parties can trade only a certain number of contracts;
- futures allow you to trade assets, regardless of their quality, only mutual consent is enough; for futures contracts, the exchange sets the quality;
- a forward has limited liquidity, while a futures is considered highly liquid (although this indicator varies depending on the underlying asset).
Good day to all. You won't get bored with my work. Especially after we started cooperating with foreign clients. Just got back from China yesterday. The country is interesting, but there was no time to get to know it.
I had to work hard on one deal according to a special scheme. Now you will understand everything. So, forward contracts are the topic of our discussion today.
I will show you all the ins and outs of such transactions. Therefore, let's proceed to the analysis without delay, dear readers!
Forward Contract and Price: Definition and Examples
A forward contract is a futures contract that is usually entered into off-exchange. This is an individual contract that meets the needs of counterparties.
It is concluded to carry out a real sale or purchase of the underlying asset and insure the seller or buyer against possible adverse price changes.
The conclusion of the contract does not require any costs from counterparties (here we do not take into account possible overhead costs associated with the execution of the transaction, and commissions if it is concluded with the help of an intermediary).
The execution of the contract takes place in accordance with the conditions that were agreed upon by the participants at the time of its conclusion.
Example 1 On April 30, person X entered into a forward contract with person Y for the delivery on September 1 of 100 shares of company A at a price of 100 rubles. for one share. In accordance with the terms of the contract, person X will transfer 100 shares of company A to person Y on September 1, and person Y will pay 10,000 rubles for these securities.
A forward contract is a firm deal, i.e. a deal that is binding.
A person who undertakes to buy the underlying asset under a contract enters a long position, i.e. buys a contract. The person selling the underlying asset under the contract opens a short position, i.e. sells the contract.
The subject of forward contact can be different assets. However, in world practice, the forward currency market has received the widest development, and forward contracts are actively used to hedge currency risk.
Let us give examples of currency risk insurance with the help of a currency forward.
Example 2 The importer plans to buy goods abroad in three months. He needs currency. In order not to take risks, he decides to hedge the purchase of currency with a three-month forward on the US dollar.
Banks offer three-month contracts at a price of $1=30 rubles. The importer buys a contract at this quote, that is, he concludes a contract with the bank, under which he undertakes to buy dollars.
Three months pass, the importer pays 30 rubles under the contract. for one dollar and receives the contract amount.
At this point, the situation in the spot market can be any. Let's say the dollar exchange rate was 31 rubles. However, under the contract, the importer receives a dollar at 30 rubles.
Let the dollar exchange rate be equal to 29 rubles in three months, but the importer is obliged to fulfill the terms of the transaction and buy the dollar for 30 rubles.
Thus, the conclusion of the forward contract insured the importer against unfavorable market conditions, but did not allow him to take advantage of the favorable situation.
IN this example there is a general pattern for futures contracts, namely: if they are insured against an increase in the price of the underlying asset, then they buy a contract, i.e. secure the purchase price for the future.
Example 3 Let in the conditions of example 2, instead of an importer, an exporter appears. In three months, he should receive foreign exchange earnings, which he plans to convert into rubles.
In order not to risk, the exporter hedges the future sale of dollars with a forward contract. He sells a forward for dollars to the bank, i.e., he concludes a contract with the bank, under which he undertakes to sell dollars to the bank at a price of 30 rubles. per dollar.
Attention!
Three months pass, the exporter delivers dollars under the contract at a price of 30 rubles. for one dollar and receives the contract amount.
The situation in the spot market at this moment can be any. Let's say the dollar exchange rate was 29 rubles. However, under the contract, the exporter sells the dollar at 30 rubles.
Let the dollar exchange rate be equal to 31 rubles in three months, but the exporter is obliged to fulfill the terms of the transaction and sell the dollar for 30 rubles.
Thus, the conclusion of a forward contract insured the exporter against unfavorable market conditions, but did not allow him to take advantage of the favorable situation.
In this example, a general pattern arises for futures contracts, namely: if they insure against a fall in the price of the underlying asset, then they sell the contract, i.e. secure the selling price for the future.
Despite the fact that the forward contract assumes mandatory performance, counterparties are not insured against its non-performance due to, for example, bankruptcy or bad faith of one of the participants in the transaction. Thus, a forward contract is characterized by credit risk.
A forward contract may be concluded for the purpose of playing on the difference in the market value of assets.
A person who opens a long position expects an increase in the price of the underlying asset, a person who opens a short position expects a decrease in its price. Let us explain what has been said with examples.
Example 4 Up game. Let the speculator appear instead of the importer in Example 2. He expects that the dollar in three months will be 31 rubles. Therefore, the speculator buys a contract with a quote of 1 USD = 30 rubles.
If the dollar exchange rate has fallen to 29 rubles by this moment, the speculator loses 1 ruble. He is obliged to fulfill the forward contract, i.e. buy a dollar for 30 rubles, but can now sell it only for 29 rubles.
In this example, a general pattern arises for futures contracts, namely: if they play for an increase, then they buy a contract, benefit from a price increase and lose from its fall.
Example 5 Fall game. Let in the previous example, the speculator expects the dollar to fall in three months to 29 rubles. He plays for a fall, i.e. sells a contract for 30 rubles.
Three months later, the dollar is worth 29 rubles. The speculator buys it on the spot market for 29 rubles. and delivers under a forward contract for 30 rubles, winning a ruble.
Let the dollar cost 31 rubles. To fulfill the contract, the speculator is forced to buy a dollar on the spot market for 31 rubles. and deliver it under the contract for 30 rubles. His loss is 1 rub.
In this example, a general pattern arises when concluding futures contracts, namely: if they play for a fall, then they sell the contract, benefit from a price decrease and lose from its growth.
Foreign exchange forward contracts, as a rule, have standard maturities. Usually it is 1, 2, 3, 6, 9 and 12 months.
According to its characteristics, the forward contract is individual.
That's why secondary market forward contracts for most of the assets is not developed or underdeveloped. The exception is the forward foreign exchange market.
Forward price and delivery price
When concluding a forward contract, the price at which the transaction will be executed is agreed upon. It is called the delivery price. It remains unchanged throughout the duration of the contract.
There is also the concept of the forward price of the underlying asset. This is the price of an asset for a certain time in the future, such as a three-month forward price, a six-month forward price, and so on.
When the parties to a contract agree on a delivery price, they take into account market conditions at that point and record this price as the delivery price under the contract.
Since this price takes into account all the conditions of the conjuncture, then at this moment it is also the forward price of the asset for a certain point in time in the future.
At the following points in time, the market conditions will change, therefore, in new contracts for this asset, which expire simultaneously with our first contract, there will also be new price delivery and, accordingly, the new forward price of the underlying asset.
Attention!
Therefore, we can say that for each point in time, the forward price of the underlying asset is the delivery price of the forward contract that was entered into at that moment.
Thus, in the market at each moment of time for a certain date in the future there is a forward price of the underlying asset and it is equal to the delivery price of forward contracts concluded at that moment.
Example. On March 1, a forward contract is concluded for the delivery of shares of company A on July 1 at a price of 100 rubles.
At the moment the contract is concluded, the forward price of a share with delivery on July 1 is equal to the delivery price, i.e. 100 rubles. On April 1, another contract is concluded for the delivery of shares of company A on July 1 at a price of 120 rubles.
The new contract has a new delivery price, as the market situation has changed.
Thus, the forward price of a share on April 1 (with delivery on July 1) is equal to the delivery price of the second contract, i.e. 120 rubles. In this case, the delivery price for the first contract remains equal to 100 rubles, but the forward price of the share for delivery on July 1 at this moment is 120 rubles.
Source: http://website/mathhelpplanet.com/static.php?p=forvardniy-kontrakt-i-cena
Future trade agreements
In a forward contract, the parties at the time of the conclusion of the transaction necessarily stipulate among themselves all the necessary conditions contract and a specific asset for sale or purchase, its quality, contract size, contractual execution price (delivery price), delivery time and place. From this follows the following definition of a forward contract.
This is a material agreement between two or more entities foreign economic activity and their foreign counterparties, aimed at establishing, changing or terminating their mutual rights and obligations in foreign economic activity.
A forward contract or forward is an agreement between two counterparties on the terms of a transaction with an underlying instrument (asset) that will take place in the future.
Most often, such transactions take the form of buying or selling a specified amount of a specific type of underlying instrument at a fixed price at a certain date in the future.
A forward contract has a number of advantages, namely:
- as a rule, the object of trading in forward transactions is a product that will still be manufactured (grown) at the time of delivery, so bidders plan their profit in advance;
- the seller (commodity producer) has the opportunity to receive an advance payment from the buyer within 50% of the contract value and use it for the production of products;
- the buyer is insured against price increases and is provided with the supply of products for their own production (resale).
Despite the fact that the forward contract provides for mandatory performance, the counterparties are not immune from its failure, for example, bankruptcy or bad faith of one of the participants in the transaction.
Therefore, before concluding a deal, partners should find out the solvency and reputation of each other.
Conclusion of the contract "Forward"
The conclusion of the contract consists of at least two stages: the proposal of one party to conclude a contract and the acceptance of the proposal by the other party.
Typically, forward contracts are used when delivering a large volume of goods.
For example, in the spring, an exporter enters into a forward contract with a commodity producer for the supply of produced grain.
In this case, the parties are trying to resolve the issue of pricing at the stage of concluding a contract, and payment for the goods is negotiated separately.
Exporters who take part in international tenders get the right to deliver a certain volume of goods at a certain price, which is also the essence of a forward contract.
When signing the forward terms of the transaction, the parties pursue the mutual goal of mutual fulfillment of the appropriate requirements for both one and the other party to the contract.
Previously, an export contract is a written document containing an agreement between the parties on the supply of goods: the exporter's obligation to transfer certain goods to the buyer's property and the importer's obligation to accept this product and pay for it the necessary sum of money or obligations of the parties to comply with the terms of the trade transaction.
The foreign economic contract of sale contains an introductory part, details of the parties ( legal address And Bank details) and the following basic conditions:
- Subject and object of delivery (name and quantity of goods);
- Methods for determining the quality and quantity of goods;
- Time and place of delivery;
- Basic terms of delivery;
- Total price – delivery cost;
- Conditions of payment;
- The order of delivery and acceptance of goods;
- Transport conditions;
- Terms of guarantees and sanctions;
- Settlement of disputes;
- Circumstances of exemption from liability, force majeure.
The contract is signed by authorized persons and their signatures are sealed.
Source: http://site/agrex.gov.ua/forvardnyiy-kontrakt/
What are forward transactions?
A forward transaction is a transaction between two parties, the terms of which provide for a mandatory mutual one-time transfer of rights and obligations in respect of the underlying asset with a deferred date for the execution of the agreement from the date of the agreement.
Such a transaction is usually made in writing. The subject of the agreement can be various assets - commodities, stocks, bonds, currency, etc.
A forward contract is usually entered into for the purpose of actual sale or purchase of the relevant asset, including to insure the supplier or buyer against possible adverse price changes.
A forward contract may also be concluded for the purpose of playing on the difference in the rates of the underlying asset.
When concluding a forward contract, the parties agree on the price at which the transaction will be executed. This price is called the delivery price. It remains unchanged for the duration of the forward contract.
Attention!
In connection with a forward contract, the concept of a forward price also arises. For each point in time, the forward price for that underlying asset is the delivery price fixed in the forward contract that was entered into at that point in time.
When determining the forward price of an asset, it is assumed that the depositor at the end of the period should receive the same financial results by purchasing a forward contract for the delivery of an asset or the asset itself.
In case of violation given condition there is an opportunity to make an arbitrage operation. If the forward price is higher (lower) than the spot price of the asset, then the arbitrageur sells (buys) the contract and buys (sells) the asset.
Spot price - the current market price of the underlying asset. When entering into a forward transaction, the party that opened a long position hopes to further growth prices of the underlying asset.
When the price of the underlying asset rises, the buyer of the forward contract wins and the seller loses, and vice versa.
Gains and losses on a forward trade are realized only after the expiration of the contract, when there is a movement of cash and assets.
The conclusion of a forward contract does not require any costs from the counterparties, with the exception of possible commissions associated with the execution of the transaction, if it is concluded with the help of intermediaries.
Despite the fact that a forward contract implies a mandatory performance, theoretically counterparties are not insured against default on the part of their partner due, for example, to bankruptcy or bad faith of one of the participants in the transaction.
Therefore, before concluding a deal, partners should find out the solvency and integrity of each other.
The absence of guarantees for the performance of a forward contract in the event of an appropriate market situation for one of the parties is a disadvantage of a forward contract.
Another disadvantage of forward contracts is their low liquidity. Forward transactions are made off exchanges in unorganized markets.
All terms of the transaction - terms, price, guarantees, sanctions - are negotiated by the parties: since a forward transaction, as a rule, pursues the actual delivery of the corresponding asset, the counterparties agree on conditions that are convenient for them.
Thus, the forward contract is not standard in its content.
It is believed that, as a result, the secondary market for forward contracts is either very narrow or non-existent, since it is difficult to find any third party whose interests would exactly correspond to the terms of this contract, originally concluded within the framework of the needs of the first two parties.
In fact, the degree of liquidity of the forward market directly depends on the degree of liquidity of the underlying asset.
For some underlying assets - for non-exchange goods, for unlisted corporate securities - it will be narrow and illiquid, for others, on the contrary, it will be liquid, for example, for currency, government securities.
If the underlying asset is liquid, an arrangement executed in a forward contract may also be liquid. To do this, the parties provide for the possibility of transferring the contract to third parties during the term of the agreement.
Thus, we can talk about the purchase and sale of forward contracts, which is still based on the purchase and sale of the underlying asset.
If a forward contract is sold in the secondary market, then it acquires a certain price because there is a difference between the delivery price and the current forward price.
The shape of the forward curve - the dependence of the prices of futures contracts on their term - significantly affects the behavior of spot market participants.
When the prices of contracts with a longer expiration date are higher than the prices of near contracts, the market is in a state of contango.
The shape of the price curve in this case allows us to conclude that the price of the underlying asset is expected to rise in the future, and the profitability of the buying and holding strategy stimulates buyers and leads to an increase in inventories, while the intertemporal spread should be comparable to the cost of storing goods.
If the prices of distant contracts are lower than the prices of nearby ones, i.e. the forward price curve is inverted, the market is in a state of backwardation.
This shape of the curve leads to the fact that the accumulation of inventories becomes unprofitable for companies, which leads to their reduction.
At any given moment, the market absorbs all available information and sets spot and forward rates. At this point, the forward rate predicts the value of the spot rate in the future.
However, various economic and political events and even catastrophes are possible during this time. All this changes market forecasts and is reflected in prices.
Not surprisingly, these rates turn out to be different in the end, and their difference does not contradict the facts of the coincidence of forward rates and predicted values of future spot rates.
In order for the forecast to be correct, the participant must today correctly predict unexpected events that will occur before the execution of the forward transaction.
Prolongation transactions "report" (repo) and "deport" (reverse repo) act as a kind of short-term forward contract.
A repo is an agreement between counterparties, according to which one party sells securities to another with an obligation to buy them back from it after some time at a higher price.
As a result of the transaction, the first party actually receives a loan secured by securities.
The interest on the loan is the difference in prices at which she sells and redeems the paper. Her income is the difference between the prices at which she first buys and then sells securities.
A repo transaction is an over-the-counter futures transaction. One party to the transaction is, for example, a speculator who has entered into a transaction for a period in order to obtain an exchange rate difference.
The need for a prolongation transaction arises for him if the change in the exchange rate he predicted did not take place and the liquidation of the transaction does not bring profit.
However, the professional who made the deal expects that his forecast for a change in the exchange rate will come true in the near future, so it is necessary to extend the terms of the deal, i.e. prolong it.
Thus, a prolongation transaction is concluded by him in order to make a profit at the end of its term from the speculations he conducts under the transaction agreement concluded earlier. Deportation is much less common on the market - an operation that is the opposite of a report.
This trade is used by a bear, a professional short trader, when the price of a security has not gone down, or has gone down only slightly, and he is counting on a further fall in the price.
Deportation is also applied in the case when it is necessary to supply securities to your counterparty, and the broker or dealer does not have these securities. Then he resorts to deportation to fulfill his obligations.
A reverse repo is an agreement to buy securities with the obligation to sell them at a later date at a lower price.
In this transaction, the person who buys the paper at a higher price actually receives it as a loan secured by money.
The second person providing a loan in the form of securities receives income (interest on the loan) in the amount of the difference in the sale and redemption prices of securities.
Source: http://site/cic.ru/?page=3
Why FC are the basis of all derivatives
Most complex view Investment products fall under the broad category of derivatives, or derivatives. Most investors find it difficult to understand the concept of a derivative.
However, derivatives are used by government and banking institutions, asset management companies and other corporations to manage investment risk.
Therefore, it is important for investors to have a general understanding of this type of product and how professional investors use them.
Overview of a forward derivative contract
As a type of derivative product, forward contracts are a good example to give an overview of more complex derivatives such as futures, options and swap contracts.
Forward contracts are very popular because they are not regulated by the government, they guarantee the confidentiality of the seller and the buyer, and can also be modified to suit the requirements of both.
Attention!
Unfortunately, due to the opacity of forward contracts, the size of the forward market is essentially unknown. In turn, because of this, the principle of the forward contract market is less clear to investors compared to other derivatives markets.
Since forward contracts lack “transparency” at all, a number of questions can arise when using them. For example, the parties to a forward contract are subject to credit risk, or the risk of non-payment.
Closing the trade can be problematic due to the lack of a formal clearinghouse. Large losses are also likely if the derivative contract is not properly structured.
As a result, in forward markets, there can be serious difficulties in moving funds from participants in this type of transactions to society as a whole.
Today, such problems as the systematic non-fulfillment of obligations by the parties to a forward contract have not yet been resolved.
Nevertheless economic principle"too big to fail" will always sound tempting as long as large institutions are allowed to guarantee forward contracts.
The problem gets even bigger when the options and swaps market is taken into account.
Trading and settlement procedures
Forward contracts are traded on the OTC market. They are not traded on exchanges such as the NYSE (New York stock Exchange), NYMEX (New York commodity exchange), CME (Chicago Mercantile Exchange), and CBOE (Chicago Options Exchange).
When the forward contract expires, the trade can be settled in one of 2 ways.
The first of these is carried out by "delivery". This type of arrangement implies that the party holding the "long" forward contract will pay the funds to the holder of the short position in this contract when the asset is delivered and the transaction is completed.
Although the essence of the concept of "delivery" is easy to understand, the direct delivery of the relevant asset can be very difficult for the owner of a short position.
Therefore, forward contracts can also be settled in another way, known as "cash settlement".
This type of settlement is more complicated than "delivery", but nevertheless it is quite logical.
For example, suppose that at the beginning of the year, a grain company entered into a forward contract with a farmer to buy 1 million bushels of grain (1 bushel in the US is approximately 35.2 liters) on November 30 of that year at a price of $5 per bushel.
Let us assume that by the end of November the price of grain for open market reached $4 per bushel. Thus, a company that went long on a forward contract should receive an asset from the farmer that is now worth $4 per bushel.
However, since the parties agreed at the beginning of the year to pay $5 per bushel, the company can simply ask the farmer to sell the grain on the open market at $4 per bushel and then make a cash payment to the farmer at $1 per bushel.
Then the farmer will get the same $5 per bushel of grain. On the other side of the deal, the company would then simply purchase the required number of bushels of grain on the open market at $4 per bushel.
As a result, the company will settle with the farmer in the form of $ 1 for each bushel of grain. In this case, cash was used to simplify the delivery process.
Overview of currency FC
The terms of use of derivative contracts can turn them into a complex financial instrument. A foreign exchange forward contract is a good example.
However, before understanding the essence of a currency forward transaction, it is important to understand how currencies are quoted to the public and how they are used by institutional investors.
This type of conversion is very popular and is known as an indirect quote. Most investors, most likely, this is how they imagine currency exchange.
However, institutional investors financial analysis use the direct quote method. Here the amount of national currency per unit of foreign currency is determined.
This method was developed by securities industry analysts because institutional investors think in terms of the amount of national currency per unit of a particular share, and do not calculate how much shares can be bought for one unit of national currency.
Attention!
Given this distinction, it is a direct quote that will be used to explain how a forward contract can be used to implement a covered interest arbitrage strategy.
Let's assume that an American foreign exchange trader works for a company that regularly sells its goods in Europe for euros, after which they need to be converted back into US dollars.
In this case, the trader will most likely know the spot and forward rates between the US dollar and the euro on the open market, as well as the risk-free rate of return for both currencies.
For example, a currency trader knows that the US dollar to euro spot rate on the open market is $1.35 per euro, the US annualized risk-free rate is 1%, and the European risk-free interest rate is 4%.
An annual foreign exchange forward contract on the open market is quoted at $1.50 per euro.
Having on hand this information, a currency trader is able to determine if covered interest arbitrage is possible, as well as how to open a position to earn a risk-free return for the company using a forward contract.
Covered Interest Arbitrage Strategy Example
Before turning to a covered interest arbitrage strategy, a currency trader first needs to determine what a forward contract between the dollar and the euro should be in terms of effective interest rates.
To do this, you need to make the following calculations: the spot rate of the US dollar for the euro is divided by the sum of one and the annual risk-free rate in the EU, and then multiplied by the sum of one and the annual risk-free rate in the US.
x(1 + 0.01) = 1.311
In this case, a one-year forward contract between the dollar and the euro should sell for $1.311 per euro. Since a similar one-year forward contract on the open market sells for $1.50 per euro, the currency trader realizes that the price of the forward contract on the open market is too high.
Since anything overpriced will subsequently be sold for profit, the far-sighted foreign exchange trader will sell the forward contract and purchase euros in the spot market to earn the risk-free rate of return on the investment.
You can carry out the covered interest arbitrage operation in the following way:
Step 1: The currency trader needs to have $1.298 and purchase €0.962 with it.
To determine the amount of US dollars and euros required to implement the strategy of covered interest arbitrage, we need to divide the spot price of the contract (1.35 dollars per euro) by the amount of unit and the annual risk-free rate in the EU (4%):
1,35 / (1 + 0,04) = 1,298
In this case, $1,298 is needed to facilitate the transaction. The trader then determines how many euros are needed to facilitate the trade.
To do this, the unit is divided by the sum of the unit and the European annual risk-free rate (4%). The result is 0.962 euros.
1 / (1 + 0,04) = 0,962
Step 2: The trader needs to sell the forward contract in order to receive EUR 1.0 at the price of USD 1.50 by the end of the year.
Step 3: Hold the euro position for a year, thus the trader earns interest in the amount of the European risk-free rate (4%).
This EUR position will increase in value from EUR 0.962 to EUR 1.00.
0.962 x (1 + 0.04) = 1.000
Step 4: Finally, when the forward contract expires, the trader will bet EUR 1.00 and receive USD 1.50.
The trade described would be equivalent to a risk-free rate of return of 15.6%. You can determine it by dividing $1.50 by $1.298 and then subtracting one from the resulting amount.
(1,50 / 1,298) – 1 = 0,156
It is very important that investors understand the mechanics behind the covered percentage arbitrage strategy.
This is a good illustration of why interest rate parity must always hold in order to prevent unlimited risk-free returns.
Relationship with other derivatives
Forward contracts can be designed in such a way that they turn into very complex financial instruments.
The variety of forward contracts is increasing exponentially when you consider how many various types basic financial instruments can be used when working with forward contracts.
Attention!
Examples include securities forward contracts based on portfolios of individual securities or indices, fixed income forward contracts based on securities (such as Treasury bills), and interest rate forward contracts (such as LIBOR), better known as an agreement on a future interest rate.
It is also important for investors to understand that forward derivative contracts are generally considered the basis for futures, options and swap contracts.
The reason lies in the fact that futures contracts are basically standardized forward contracts with a formal exchange and clearing house.
Option contracts are essentially forward contracts that provide the investor with the right, but not the obligation, to complete the transaction at some point in the future.
Swap contracts are agreements in the form of a chain of forward contracts that require certain periodic actions from the investor.
Once the link between forward contracts and other derivatives is clear, investors can quickly understand the variety of financial instruments available and understand the implications of using derivatives in terms of risk management.
It also becomes clear how important the derivatives market is for government and banking institutions, as well as for large corporations around the world.
forward contract- a certain agreement concluded between the two parties on the forthcoming delivery of the underlying asset.
The existing terms of the contract are negotiated at the time of its conclusion. A forward contract is executed on the basis of these conditions and on time.
What are the features of a forward contract?
The conclusion of a forward contract does not provide for any costs, with the exception of those commissions that will be spent on processing the transaction, if it is carried out with the help of an intermediary.
Is forward contract, usually for the purpose of buying or selling a required asset, in addition to insuring a supplier or some buyer against a potentially unwanted price change. Counterparties, on the other hand, are insured against undesirable developments, not being able to take advantage of a potentially favorable market situation.
The terms of the forward contract stipulate the obligation to perform, but despite this, the counterparties are still not 100% insured against its non-performance. For example, due to the bad faith of any of the participants in the transaction or the bankruptcy of the company. Therefore, before concluding a deal, you need to make sure that both parties are solvent and reputable.
Also, a forward contract can be concluded, in which the goal is to play on the difference in the value of the asset rate. A buying analyst expects the price of the underlying asset to rise, and a selling analyst expects the asset price to fall.
For its primary purpose, a forward contract is considered an individual type of contract. For this reason, other markets for forward contracts for a large share of assets are poorly developed or not developed at all. An exception here may be forward.
When signing a forward contract, both parties agree on the price of the transaction. This price is called the delivery price, after which it remains constant throughout the duration of this forward contract.
With the advent of the forward contract, the concept of a certain forward price appeared. Relative to each time interval, the forward price, for the current underlying asset, is the delivery price noted in the contract signed to date.
Legal features and types of forward contracts
Let us examine in more detail the legal features of forward contracts. As we have already said, the forward type of contract involves the real delivery of any product as the final result. Since the object of the forward is the real product, that is, the things that are available. With all this, the reference to the validity of the goods should in no way infringe on the right of the seller to conclude a contract for the sale of goods that will be manufactured or purchased by the person selling the goods in the future.
A forward contract is enforced some time later, after its direct conclusion.
A forward is a justified opportunity to insure profits.
Before concluding such an agreement, its important conditions are stipulated, namely:
- terms
- total quantity of goods
- its price, which is not completed before a specific delivery date.
This type of risk insurance is called hedging in the market. base price goods in all forward transactions is different from its price in cash transactions. In addition, it can be set both at the time of signing the contract, and during the calculation and delivery.
The execution cost of a forward transaction (which is determined for the period of its implementation) is some average exchange price indicator for this product.
The forward price is the result of the participants' assessment of all possible factors influencing the market, and all further prospects for the development of related events on it.
Price ratio in forward contracts
In the process of development of the foreign exchange market, forward contracts began to be divided according to the method of delivery into the following types:
delivery type of forward contracts;
further, settlement forward contracts, in other words, non-deliverable types of forward contracts.
As for supply contracts, the delivery under them is calculated initially, and mutual settlement is made by paying one of the parties the resulting difference in the cost of the goods or a previously established amount, based on the terms of the contract.
When working with settlement types of contracts, the delivery of goods (ie the underlying asset) is not provided from the beginning of the transaction. Such contracts allow the losing party to pay a set amount of money, the difference between the price itself, stipulated in the contract and the current market price on a specific date.
The calculation for this amount (also called the variation margin) is made at a previously appointed time, as a rule, in relation to the delivery of the basis.
Determining the forward price
Based on the theory, in the process of determining the forward price, 2 concepts are usually distinguished:
The first is that the forward price arises as a result of the upcoming expectations of all participants in the futures exchange, in relation to the upcoming spot price.
The second type of concept is based on the arbitrage method. According to the provisions of the primary concept, all participants in economic relations are trying to take into account and consider all the information that they have in relation to the upcoming conjuncture and set the price of the future spot.
An arbitrage approach is built on the basis of technical mutual agreement between the current spot and forward prices, which is set without any possible risk.
The arbitrage approach is based on the following provision: on the basis of financial solution, the investor must be indifferent to receiving the underlying asset in the spot market now or under a forward contract at a later date.
During the life of the forward contract, the income on the shares will either be paid or not.
If a profit is accrued per share during the validity of the contract, then the forward price must be changed by its value, because by signing the contract, the investor will not receive his dividends. Moreover, there is a definition of the forward price of the currency itself, based on the parity of % rates, consisting in the fact that the depositor is obliged to receive an equal income from the placement of funds at a certain percentage without significant risk in foreign, and necessarily.
Forward contract and mutual obligations
(forward, English forward contract) is an agreement to exchange a certain amount of one currency for any other currency in the future at a price fixed at the time of the agreement. According to the contract, the seller undertakes, within the period specified in the document, to transfer the asset to the buyer or to fulfill an alternative monetary obligation. In turn, the buyer undertakes to accept the asset, pay for it in the manner and within the time period specified in the contract.
The forward can be delivered or settlement:
- DF - delivery, ends with the delivery of the asset and full payment on the terms of the contract. Deliverable forwards include an urgent OTC transaction (with deferred obligations);
- NDF - settlement (non-deliverable) does not end with the delivery of the asset.
Also, there is a forward with an open date - this is a contract with an indefinite settlement date (execution date).
At the time a forward contract is entered into, a price is set that is the current price of the underlying asset. All settlements between the parties occur exclusively at this price. When determining it, the partners proceed from the fact that at the end of the period the investor should receive the same financial result by purchasing an asset or a forward contract for its supply. If the forward price is lower (higher) than the spot price of the asset, then the arbitrageur buys (sells) the contract and sells (buys) the asset.
The subject of the agreement are various assets - stocks, commodities, currencies, bonds, etc. As a rule, a forward contract is concluded for the purpose of real purchase or sale of the relevant asset, as well as to insure the buyer or supplier against possible adverse price changes. In addition, FC can be concluded for playing on the difference in asset rates.
The price at which the contract will be executed is called the delivery price. It is unchanged during the entire period of the FC. When concluding a deal, the party that opened a long position expects a further increase in the price of the asset. When it increases, the buyer of the forward contract wins, respectively, the seller loses. Winnings and losses on FC are realized after the expiration of the contract, when there is a movement of assets and cash.
It should be noted that the conclusion of a forward contract does not require significant expenses from counterparties, with the exception of possible commission fees associated with the execution of a transaction when it is completed using the services of intermediaries. Despite the fact that FC assumes mandatory performance, counterparties are still not immune from unscrupulous partners who sometimes do not fulfill their obligations. Therefore, before concluding a deal, partners must find out the integrity and solvency of each other.
FC is concluded in unorganized markets outside the exchanges and is not standard in its content. It is believed that as a result of this, the secondary market is absent or very narrow, because. it is rather difficult to find a third party whose interests are fully consistent with the terms of the forward contract, originally concluded according to the needs of the first two parties.
Disadvantages of a forward contract
Firstly, this is the lack of guarantees for the execution of the financial statements in the event that one of the parties develops an appropriate conjuncture. Secondly, it is low liquidity.