Question

In: Finance

1) critically differentiate between forward and future contracts. (6 marks) 2 a ltd intends buy 10,000...

1) critically differentiate between forward and future contracts.

2 a ltd intends buy 10,000 Rands in three months time . the following information is available.

sport rate 0.67,the forward rate in three months is 0.7, how can a ltd hedge against foreign exchange fluctuation clearly explaining the implication to ltd should the sport rate in three months time be more or less than the forward rate?

3) differentiate between the following types of markets.

a)capital and money markets

b) primary and secondary markets

c) bond and equity markets

Solutions

Expert Solution

1] Though both forwards and futures are for buying/selling the underlying asset at a future specified date, the essential differences are:

*Performance: Forward contracts are to be performed on the due date by taking/giving delivery of the underlying and paying/receiving the value. In the of futures, usually the contracts are closed by entering in the opposite contract and then settling the difference.

*Forwards are between identified parties whereas the futures are with the futures exchange.

*Forwards are tailor made contracts but futures are standardized contracts in terms of size and maturity date.

*Forwards have counterparty risk for both sides; but futures have counterpart risk only for the exchange which, to a certain extent is covered by the maintenance margin.

2] By entering into the forward contract to buy Rands, the liability on the due date is fixed at 10000*0.67 = 6700. Irrespective of the future spot rate, the liability gets fixed at 6700.

If the future spot is more there appears to be a savings and if the future spot is less, there appears to be a loss. But, this profit or loss is only incidental to ensuring the value of the future liability.

3}

a] Capital markets deals with securities having maturity [as originally issued] of 1 year or more and money markets have maturities of less than 1 year.

b] In the primary market securities that are issued for the first time by the issuer are sold whereas in the secondary market securites that are once issued are futher bought and sold.

c] Bond market is for debt securities whereas equity market is for stocks--common and preferred.


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