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In: Finance

What are forward contracts? Discuss why individuals and companies enter into forward contracts with examples.

What are forward contracts? Discuss why individuals and companies enter into forward contracts with examples.

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Expert Solution

Forrward contracts refers to the agreement between the two parties to trade a particular assets or securities at a particular rate in the future period of time. These types of contracts are not traded at stock exchanges giving option to the parties to customise the agreement according to settlement date and price.

The companies enter into forward contracts to reduce or mitigate the risk of price fluctuations in the future, therefore, by entering into the contracts the companies can lock the price for exchange.resulting in hedging of loss.

Example: Adam runs a grocery store and sell Cookies Price at $5.00 and Now, he expect the price of cookies to reduce at $4.50 after a year, Therefore, He enter into a forward contract with the retail store that he will sell cookies at $5.00 after 1 year. Now, If the price actually went to $4.50 at year end, He will receive $5.00 for cookies from retail store instead of $4.50. Which is profitable for the Adam.


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