Understand The Forwards Market
A very important part of the derivative market is the futures market. Derivatives are those whose value is derived from the value of some other underlying asset class. Thisissomeanotherfinancial entity. The underlying security could be anything. It could be stocks, currency, commodity or bonds.
Financial derivatives have been them for a long time. The earlier usage of derivatives was in the farming industry. This was a method to price the crops which were ready to get harvested at a future time. This method was used to pay in advance for the farmers and this is what is known as the forward’s contract.
There are a lot of similarities between the forward and the futures market. You need to know about the forwards market to understand what the futures market is.
The forward contract is a simple derivate from. This is like a futures contract and it has the similar kind of a transactional structure like the futures contract. However today it is the futures contract that has become the trader’s priority. The forwards are still in use but these contracts are still used in banks and industries.
You, however, need to understand the structure of a forward contract.
Example of a forwards contract
In the earlier days, the forward market came into existence to protect the farmer’s interest from any adverse movement in the prices. In this market, the buyer, as well as the seller, enter into some sort of an agreement to exchange the goods for cash. The exchange happens at a set price on a set future date. The good price is then fixed by both the parties on a particular day that they enter into some agreement. The date, as well as the time when the goods will be delivered, is also fixed. This agreement does not involve any the third party. The forward contract is traded only over the counter where the institution’s trade based on negotiations which are on one to one basis.
Another example of forwarding contract
Take the example of a jeweler who designs and manufactures the jewelry. He buys the gold from an importer of gold who sells the gold at a wholesale price to the jeweler.
The two parties enter into a contract to buy say 10 kgs of gold in three months’ time. They also fix the price of gold at the current price of the market.
This is a straightforward way and an agreement that is prevalent in the business market today. And this agreement is known as the forward contract. Whatever be the price of gold on the set date the importer has to sell the gold to the manufacturer at the predetermined price. Both have to honor this agreement.