foreign%20exchange%20currency%20forward%20and%20spot%20prices

Foreign%20exchange%20currency%20forward%20and%20spot%20prices

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Currency: Forward and Spot Prices In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today.[1] This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a forward contract. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into. The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time of trade is not the time where the securities themselves are exchanged. The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands on the spot date. The difference between the spot and the forward price is the forward premium or forward discount, generally considered in the form of a profit, or loss, by the purchasing party. Forwards, like other derivative securities, can be used to hedge risk (typically currency or exchange rate risk), as a means of speculation, or to allow a party to take advantage of a quality of the underlying instrument which is time-sensitive. A closely related contract is a futures contract; they differ in certain respects. Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets.[2] Forwards also typically have no interim partial settlements or "true-ups" in margin requirements like futures - such that the parties do not exchange additional property securing the party at gain and the entire unrealized gain or loss builds up while the contract is open. However, being traded OTC, forward contracts specification can be customized and may include mark-to-market and daily margining. Hence, a forward contract arrangement might call for the loss party to pledge collateral or additional collateral to better secure the party at gain. [clarification needed] Contents [hide] 1 Payoffs 2 How a forward contract works 3 Example of how forward prices should be agreed upon 4 Spot - forward parity 4.1 Investment assets 4.2 Consumption assets 4.3 Cost of carry 5 Relationship between the forward price and the expected future spot price 6 Rational pricing 6.1 Extensions to the forward pricing formula 7 Theories of why a forward contract exists 8 See also
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9 Footnotes 10 References 11 Further reading [edit] Payoffs The value of a forward position at maturity depends on the relationship between the delivery price (K) and the underlying price (ST) at that time. For a long position this payoff is: fT = ST − K
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This note was uploaded on 11/15/2011 for the course FIN 4420 taught by Professor Billiebrotman during the Fall '11 term at Kennesaw.

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Foreign%20exchange%20currency%20forward%20and%20spot%20prices

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