Forward contracts are a type of financial instrument that is commonly used in the world of trading. They are a useful tool for managing risk and mitigating losses. In this article, we will discuss the characteristics of forward contracts on Quizlet.
Firstly, forward contracts are bilateral agreements between two parties to exchange an underlying asset at a predetermined future date and price. The asset can be anything that can be traded, including currencies, commodities, and securities. Unlike options contracts, forward contracts are binding and cannot be canceled or traded.
Secondly, forward contracts are traded over-the-counter (OTC), which means that they are not traded on a public exchange. This gives the parties more flexibility in negotiating the terms of the contract.
Thirdly, forward contracts are customizable to meet the specific needs of the parties involved. The price, quantity, and delivery date of the underlying asset can all be negotiated. This makes forward contracts ideal for hedging against specific risks that may be unique to a particular business or industry.
Fourthly, forward contracts require an initial margin payment from both parties. This margin serves as collateral to ensure that both parties fulfill their obligations under the contract. The margin is also used to cover any losses that may occur due to fluctuations in the market price of the underlying asset.
Finally, forward contracts are settled through physical delivery of the underlying asset on the agreed-upon delivery date. This means that the buyer is obligated to purchase the asset and the seller is obligated to deliver the asset. However, it is not uncommon for parties to settle the contract through a cash payment, especially if the underlying asset is not easily transferable.
In conclusion, forward contracts are a valuable tool for managing risk and mitigating losses in the world of trading. They are customizable, bilateral agreements that are settled over-the-counter and require an initial margin payment. If you are considering using forward contracts, it is important to understand their characteristics and how they can be used to benefit your business.