A forward contract is a type of contract between two parties for the delivery of the subject of a contract (underlying asset) at a specific time in the future, at a predetermined price. Such a document is concluded for the purchase (sale) of a certain amount of a tangible or financial asset.
Each of the parties assumes the fulfillment of the obligations stipulated in writing: one - to make the delivery, the other - to accept it. Initially, the transaction price is satisfied, which suits all parties. It is called the delivery price and is unchanged throughout the term of the contract.
A person undertaking an obligation to supply assets opens a short position (that is, sells a contract). The other side of the transaction, acquiring the asset, in turn, opens a long position (that is, buys a contract). The execution of the transaction does not require any costs from the counterparties, except for commissions when concluding it with the help of intermediaries.
A forward contract is signed with the aim of making a real purchase (sale) of various kinds of assets and insuring the buyer (as well as the supplier) against a possible change in price in a direction unfavorable for any participant. Such a contract requires mandatory performance. In some cases, however, there are risks, for example, with the bankruptcy of one of the participants. Therefore, in order to protect yourself, before concluding this kind of transaction, you need to find out the reputation and make sure of the solvency of the future counterparty.
Sometimes a forward contract is concluded for the purpose of making a profit due to the difference in the exchange value of assets. This is done in case of expecting an increase or decrease in the prices of the basic product.
Such a contract is individual, therefore, as a rule, it is not used in the secondary market. An exception is the forward foreign exchange market.
As a result of the conclusion of the contract , the actual delivery of the goods is considered. Forward transaction subject - available goods. Such a contract is carried out strictly during the period established by the contract.
Forward is an excellent profit insurance tool. The transaction concluded fixes the conditions existing at the time of signing the documents: price, due date, quantity of goods, etc. Such insurance of the parties against changes in the original terms of the transaction is called hedging.
As a rule, the cost of goods for such transactions does not coincide with the prices of cash transactions. It represents the average exchange value of the price of a particular product. Forward value is determined by the participants in the transaction, based on the assessment of all factors and prospects that affect the state of the market.
Features of the financial market led to the fact that the forward contract began to be divided into settlement transactions (non-deliverable) and delivery transactions. The latter involve the delivery and settlement by transferring the difference formed in the price of the product, or the amount previously agreed upon under the contract.
Under the forward contract, dividends on shares are expected to be paid or non-payment is specified. When they are paid during the transaction period, its price is adjusted by the amount of the dividends listed, based on the fact that subsequently (after the acquisition of the contract), the investor will cease to receive them.
Thus, a forward is a fixed-term contract, a solid transaction, which is binding. This contract cannot be called standard. Since the secondary market is very narrow, it is very difficult to find a third party whose interests would fully comply with the terms of the contract. Therefore, the deal is within the needs of only two parties. A party can liquidate a position under a contract only with the consent of the counterparty.