When a forward contract is traded on an exchange, it is called future contract or simply future. Difference between Forward and Future Contracts Forwards (or forward contracts) are private agreements between two parties. The agreement need not to be face-to-face agreement. Usually they are traded in the over-the-counter market. Whereas, futures (or future contracts) are […]

Hedging using Forwards

Consider an American company which exports to United Kingdom. The UK company pays in pounds, and the exchange rates varies from $1.4/pound (1.4 dollars per pound) to $1.6/pound (1.6 dollars per pound). The American company will receive 1 billion pounds the next year. This variability in the exchange rates mean the company is exposed to […]

Long and Short Position

What are long and short positions, and what are their payoffs? Long Position The party that agrees to buy the underlying asset in a forward contract is said to assumes long position. And, the payoff can be calculated as Short Position The party that agrees to sell the underlying asset in a forward contract is […]

Financial Derivative

Suppose you run a company that requires 10 million barrels of oil every year. The variability in the oil prices means your company is exposed to some extra risk which you would prefer to avoid. This is where financial derivatives are introduced. Financial Derivative A derivative (or financial derivative) is a contract whose value depends […]