Advantages Of Forward Contract

Advantages Of Forward Contract

04 Feb 2019 05:06 PM

In the currency markets, forward contracts are transacted over the counter like through the bank. There are two participants in a forward contract, these are hedgers and speculators. Hedgers don’t typically look for a profit however rather look to stabilize the revenues or costs of their business operations. Their gains or losses are normally offset to a point by a corresponding loss or gain in the market for the underlying asset. Speculators are typically are not interested in taking possession of the underlying assets. They basically place bets on which approach prices will go. Forward contracts tend to woo hedgers than speculators.

Forward exchange cover facility is available to Importers/Exporters to mitigate exchange risks on under document credits and Import/Export Contract. Importer/Exporter can enter into Forward Contract for sale/purchase of foreign currencies with the Bank at any time from the opening/registration of the contract subject that the period of the forward exchange cover should not exceed the validity of the contract.

Forwards specify a trade between two counter-parties. There is a commitment to deliver an asset (this is the seller), at a specified forward price. There is a commitment to take delivery of an asset (this is the buyer), at a specified forward price. At delivery, cash is exchanged for the asset. In other words in a forward contract, the purchaser and its counterparty are obligated to trade a security or other asset at a specified date in the future. A forward rate is calculated by viewing the interest rate difference between the two currencies concerned. In the forward market, the currency of a nation with lower interest rates than our nations will trade at a “premium”. The currency of a nation with higher rates than ours will trade at a “discount”.

A Forward Contract is a non-standardized contract among the two parties. These contracts are very similar to futures contracts, the only difference is they are not exchange-traded or defined on standardized assets. A forward contract is an over the counter instrument which is not traded on a centralized exchange. The party agreeing to buy the underlying asset in the future is a long position, whereas the party agreeing to sell the asset in the future assumes a short position.

The advantages of the forward contract are as follows;

  • It offers a complete hedge
  • They can be matched against the time period of exposure as well as for the cash size of the exposure
  • Forwards are tailor-made and can be written for any amount and term
  • Forwards are over the counter products
  • The use of forwards provide price protection
  • They are easy to understand

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