1. FINANCIAL DERIVATIVES

2. FINANCIAL DERIVATIVES/SNSCT/MBA
Forwards
A forward contract is a customized contract between two entities.
settlement takes place on a specific date in the future at today's pre-agreed price.
They are not traded on an exchange.
Usually between two financial institutions or between a financial institution and one of its client.
Bilateral contract, hence it is exposed to counter party risk. So these are riskier than to future contracts.
FINANCIAL DERIVATIVES/SNSCT/MBA

3. FINANCIAL DERIVATIVES/SNSCT/MBA
Video transcript
Every year this apple farmer produces one million pounds of apples. But he's got a problem. Every year the apple price jumps around a bunch. Sometimes it sells after the harvest for over $0.30, and this guy makes a ton of money per pound. And then sometimes it drops down to $0.10 per pound, and this guy can't even cover his costs. And on the other side of the equation, you have this pie chain right over here. So they specialize in making apple pies. And when the price of apples goes super high, these guys can't cover their costs. They start running a loss. But when the price goes really low, they have this kind of bonanza. But neither party here likes this scenario. They don't like the unpredictability of one year having a feast and then one year having a famine. So what they can do is, let's say we have the harvest coming up. The pie farmer is kind of afraid. Well, what if the price of pies goes back down to $0.10 per pound? Then he's going to go broke. The pie chain is afraid. What the price of pies goes up to $0.30 a pound? Then these guys are going to go broke. So what they can do is agree ahead of time, regardless of what the actual market price of pies ends up being after the harvest, they could agree to transact at a specified price. So they could set up a little contract right here. So they could set up a contract where the chain agrees to buy one million pounds at a specified date,-- let's just say after the harvest-- at the harvest for $0.20 a pound. This works out well for the chain because regardless of what the market price ends up being, they can ensure that they will pay $0.20 a pound, which is a good price where they could make a decent profit and at least they have the predictability and they can plan on things. And it works out for the farmer because he knows that a $0.20 a pound, he can cover his costs and pay his rent and pay his employees and feed his family. And it also takes out the unpredictability, the volatility for him as well. So what we have set up right here is actually called a forward contract. This is a forward contract. And what it is, as you can see, is in agreement and it's an obligation for both parties to transact in the future at a specified price. So at the time of this harvest when they write this contract, they would specify this date-- I don't know what it might be-- November 15. And at November 15, this farmer is obligated to deliver million pounds of apples. And then this pie chain is obligated to produce the money, to pay $0.20 a pound or essentially produce $200,000. And that way, they both are essentially able to avoid the volatility and make sure that they can survive.
FINANCIAL DERIVATIVES/SNSCT/MBA

4. FINANCIAL DERIVATIVES/SNSCT/MBA
Forward Contracts
A forward contract is an agreement between parties to buy or sell an underlying asset on a specified date for a specified price.
One of the parties of the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price.
The other party assumes a short position and agrees to sell the asset on the same date for the same price.
Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. 
FINANCIAL DERIVATIVES/SNSCT/MBA

5. FINANCIAL DERIVATIVES/SNSCT/MBA
Future Contracts
A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, future contracts are standardized and exchange traded. To facilitate liquidity in future contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with:
Standard underlying asset,
Standard quantity and quality of the underlying asset that can be delivered, and
Standard timing of such settlement (date and month of delivery)
The units of price quotation and minimum price change
Location of settlement
A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. In future contracts, the losses as well as profits for the buyer and the seller are unlimited.
FINANCIAL DERIVATIVES/SNSCT/MBA

6. Forward Contract
A forward contract is an agreement to buy or sell an asset on a specified date for a specified price.
One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price.

7. Features of Forward Contracts
The salient features of forward contracts are: • They are bilateral contracts and hence exposed to counter-party risk. • Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. • The contract price is generally not available in public domain. • On the expiration date, the contract has to be settled by delivery of the asset. • If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged.

8. LIMITATIONS OF FORWARD CONTRACTS
• Lack of centralization of trading • Illiquidity • Counterparty risk

9. FINANCIAL DERIVATIVES/SNSCT/MBA
Relaxes
FINANCIAL DERIVATIVES/SNSCT/MBA

10. DIFFERENCE BETWEEN FUTURES AND FORWARDS CONTRACTS
Particulars
FORWARD
FUTURES
Definition
A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time at a specified price.
A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price.
Structure & Purpose
Customized to customer needs. Usually no initial payment required. Usually used for hedging.
Standardized. Initial margin payment required. Usually used for speculation.
Transaction method
Negotiated directly by the buyer and seller
Quoted and traded on the Exchange
Market regulation
Not regulated
Government regulated market (the Commodity Futures Trading Commission or CFTC is the governing body

11. DIFFERENCE BETWEEN FUTURES AND FORWARDS CONTRACTS
Particulars
FORWARD
FUTURES
Contract size
Depending on the transaction and the requirements of the contracting parties.
Standardized
Market
Primary & Secondary
Primary
Method of pre-termination
Opposite contract with same or different counterparty. Counterparty risk remains while terminating with different counterparty.
Opposite contract on the exchange.
Expiry date
Depending on the transaction
Contract Maturity
Forward contracts generally mature by delivering the commodity.
Future contracts may not necessarily mature by delivery of commodity.
Guarantees
No guarantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid
Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses
Institutional guarantee
The contracting parties
Clearing House
Risk
High counterparty risk
Low counterparty risk

12. DIFFERENCE BETWEEN FUTURES AND FORWARDS CONTRACTS
Particulars
FORWARD
FUTURES
Contract Maturity
Forward contracts generally mature by delivering the commodity.
Future contracts may not necessarily mature by delivery of commodity.
Guarantees
No guarantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid
Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses
Institutional guarantee
The contracting parties
Clearing House
Risk
High counterparty risk
Low counterparty risk

13. DIFFERENCE BETWEEN FUTURES AND FORWARDS CONTRACTS
Particulars
FORWARD
FUTURES
Traded
Trade on an organized exchange
OTC in nature
Market
Primary & Secondary
Primary
Contract Terms
Standardized contract terms
Customized contract terms
Liquidity
Hence more liquid
Hence less liquid
Margin
Requires margin payments
No margin payment
Settlement
Follows both daily settlement and Final settlement
Settlement happens at end of period

14. FUTURES VERSUS FORWARD MARKETS

15. Types of Forward Contract
Time option forward contract This is a forward contract that allows access to the funds between two pre-determined dates eg. 01/04/ /08/00. This is of particular benefit when, for example a car delivery is not precisely known, and therefore funds may be needed earlier. It is important to remember that the last date is not flexible and physical delivery of the currency can take place before but no later than that date.
Drawdown forward contract This is similar to a time option forward contract, however, if a portion of the funds are required during the life of the contract then they may be drawn down against the said contract at the original buy rate, thereby reducing the final balance. This would particularly suit either a boat or house purchase where large sums maybe needed to settle stage payments. Its structure also lends itself to corporate clients with large capital payments as the minimum is circa. £75,000. Draw down payments will incur a small fee.
Fixed term forward contract A Fixed-Term Forward Contract gives you the ability to fix a currency rate with a view to take physical delivery of the said currency in the future. The rate is guaranteed irrespective of market fluctuations for the duration of the Contract.
A deposit is required on each Forward Contract and must be received within two (2) working days of the contract date. The balance of the contract must be settled no later than the maturity date. We recommend that our clients settle the outstanding balance on their contracts five (5) working days prior to the contract matures. Should the delivery of the currency not be required upon maturity, the said currency can usually be held on account at no additional charge or penalty
FINANCIAL DERIVATIVES/SNSCT/MBA

16. FINANCIAL DERIVATIVES/SNSCT/MBA
Trade Procedure
In a forward contract, the buyer and seller are private parties who negotiate a contract that obligates them to trade an underlying asset at a specific price on a certain date in the future.
Since it is a private contract, it is not traded on an exchange but over the counter. No cash or assets change hands until the maturity date of the contract.
There is usually a clear "winner" and "loser" in forward contracts, as one party will profit at the point of contract maturity, while the other party will take a loss.
For example, if the market price of the underlying asset is higher than the price agreed in the forward contract, the seller loses.
The contract may be fulfilled either via delivery of the underlying asset or a cash settlement for an amount equal to the difference between the market price and the price set in the contract.
FINANCIAL DERIVATIVES/SNSCT/MBA