Derivative Forward Agreement

Birgit Pauli-Haack  

If these price relationships do not hold, there is a possibility of arbitration for a risk-free gain similar to the one described above. One consequence is that the existence of a futures market will require spot prices to reflect current expectations for future prices. As a result, the futures price of commodities, securities or non-perishable currencies is no longer a predictor of the future price than the spot price – the ratio of futures to spot prices is fuelled by interest rates. For perishable commodities, arbitrage does not have these speculators to try to maximize their profits by “betting” on how prices will go. You are not interested in buying or selling the core asset. Instead, they hope to take advantage of the forward contract itself by betting on the direction in which the price will go. Due to the lack of transparency associated with the use of futures contracts, some potential problems may arise. For example, parties who use futures contracts are subject to a default risk, their transactions may cause problems due to the lack of a formalized clearing structure, and may be exposed to significant losses if the derivative contract is poorly structured. As a result, there is a risk of serious financial problems in the futures markets, to pass from the parties that carry out these types of transactions to the company as a whole. Now let`s take an example of a question that uses an attacker for exchange rates. Your money is currently in U.S. dollars.

However, in a year`s time, you will have to make purchases in pounds sterling of 100,000 euros. The spot exchange rate today is 1.13 US/ , but you do not want money in foreign currency for a year. In this case, the financial institution that entered into the futures contract is exposed to a higher risk in the event of default or non-billing by the customer than if the contract was regularly put on the market. The futures market is huge, as many of the world`s largest companies use it to hedge foreign exchange and interest rate risks. But since the details of futures contracts are limited to the buyer and seller – and the public does not know – the size of this market is difficult to estimate. The situation is similar for futures contracts in which a party opens a futures contract for the purchase or sale of a currency (for example. B of a contract to purchase Canadian dollars) that expires later because it does not wish to be exposed to currency/exchange risk for a certain period of time. Because the exchange rate between the U.S. dollar and the Canadian dollar varies between the trading date and the earlier date of the contract or expiry date, one party and the counterparty lose if one currency strengthens relative to the other. Sometimes the attacker purchase is open because the investor really needs Canadian dollars at some point in the future, such as paying Canadian dollar-denominated debt.

Other times, the party that opens an attacker does so not because it needs Canadian dollars or because it secures foreign exchange risks, but because they speculate on the currency and expect the exchange rate to move favourably to generate a profit when the contract is concluded.