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There are two ways for a settlement to occur in a forward contract: delivery or cash basis. If the contract is on a delivery basis, the seller must transfer the underlying asset or assets to the buyer. The buyer then pays the seller the agreed-upon price in cash.
Thus in a forward contract, the buyer and seller have opposing views with respect to the price of the underlying asset. One party expects the price to rise, while the other expects it to fall. So at the time of execution, one party makes a gain while the other suffers a loss.
A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging.
Each FX forward contract possesses a spot and forward element. The forward element represents the interest rate differential between the two currencies. Under IFRS 9 (similar to IAS 39), it is allowed to designate the entire contract or just the spot component as the hedging instrument.
The forward market is where financial instruments and assets are sold and bought for future delivery. These financial instruments include bonds, swaps, equity, cap, futures, forward rate arrangements, bills of exchange, etc.
Assuming spot price as ST and strike price (agreed price as per forwards contract) as K, the payoff for forward contract buyer and seller will be as follows: Payoff for Long Position in a Forward Contract = ST ? K. Payoff for Short Position in a Forward Contract = K ? ST.
Contractual elements: A forward contract comprises essential components such as the underlying asset, contract size, price (also known as the forward price), delivery date, and the parties involved.
Forward contracts are contracts between two parties ? the buyers and sellers. Under the contract, a specified asset is agreed to be traded at a later date at a specified price. For example, you enter into a contract to sell 100 units of a computer to another party after 2 months at Rs. 50,000 per unit.