FINC6000_Qantitative Finance_2009 Semester 2_week 6_ForwardFutures1.doc

Quantitative Finance FINC 6000 Lecture FORWARD AND FUTURES CONTRACTS - I FORWARDS AND FUTURES FORWARD CONTRACT Definition: A contract for the delivery of a commodity or asset at a price specified today, with delivery and settlement at some specified date in the future. An agreement to buy or sell an asset at a certain time in the future for a certain price. Forward contracts are private contracts between two parties, the buyer and seller, to trade an asset or commodity at some future date. The two parties form and trade the contract privately, and agree to all details of the arrangement. In forward contracts, dates, quantities, prices and other aspects of the contract are determined by private negotiation between the two parties. The contract is an over-the-counter (OTC) agreement between 2 companies. Forward contracts are popular on FX and interest rate products. Most forward contracts specify that all claims are settled at the pre-specified date in the future (maturity or expiration date). Initial payment associated the inception of the forward contract is zero; neither party pays any money to obtain the forward contract. The value of the forward contract when initiated is zero; the forward price (the price that applies at delivery/expiration) is negotiated so that initial payment/receipt by the parties is zero. After the forward contract has been initiated, its value may vary depending on the spot price of the underlying asset, prevailing interest rates and other factors Buyer of forward contract ( long forward position ( obligation to purchase (take delivery of ) the underlying asset or commodity at some specified date in the future (expiration date) at a price specified today (forward price) Seller of forward contract ( short forward position ( obligation to sell the underlying asset or commodity at some specified date in the future (expiration date) at a price specified today (forward price) If forward price (F) Spot price