Forward Agreement Examples
Old MacDonald had a farm, and on that farm he grew corn — a lot of corn. This year, he expects to produce 500 bushels of corn. He can sell the corn at the price per bushel available at harvest time – or he can now set a price. The Crunchy Breakfast Cereal Company needs a lot of corn to make its grain. They send a representative to old MacDonalds Farm and offer him a fixed price to pay when 500 antlers of corn are delivered at harvest. Old MacDonald is delighted with the futures contract and gets the delivery price if it can deliver 500 bushel corn by a set date. Based on the expected delivery price, if he is able to produce the 500 bushels of corn, he can plan this year`s farm receipts and next year`s expenses. Crunchy Breakfast Cereal Company is also satisfied with the futures contract. Since they have a futures contract, they can control variable costs (for example.
B the cost of maize) for making their breakfast. If they know in advance the cost of corn, they can maintain price stability for the consumer. They may overpay Old MacDonald for his corn, but this is a risk they are willing to take to keep costs stable and keep market share for their cornflakes. However, a rate below K at maturity would represent a loss for the long position. If the price of the underlying fell to 0, the long item would be payment -K. The short position in advance has exactly the opposite payment. If the price falls to 0 on maturity, the short position a payment from K. Forward Contract is a binding agreement between the parties to exchange a certain number of goods at a future date determined at a price agreed today. It was the contract that made it possible to set a price of a commodity in advance. This amount is the difference between the current spot price and the futures price. Futures contracts have existed at least since Greek and Roman times. There is ample evidence that they were widely used in Europe in the Middle Ages and Europeans continued the tradition of futures contracts in the New World.
Futures contracts were used to store essential goods that could be resold profitably at a later date. Buyers would take possession of the wheat, corn or other goods upon delivery of the contract, pay the forward price (agreed in the contract) and hope that demand for the good would increase so that they could increase prices, resell them and make a profit. Although it is a zero-sum transaction (some of which wins or loses everything), futures contracts offer potential benefits to both buyers and sellers. In a zero-sum game, one party wins everyone or loses everyone. For buyers, attackers link prices, allowing them to predict and control variable raw material costs. They can guard against exchange rate volatility by setting the price with a futures contract. For sellers, futures contracts allow you to project cash flow by knowing the value of a future asset when the futures contract is concluded. Futures contracts require buyers to take possession of the goods on the date of delivery so that sellers also have the certainty to whom and until when they deliver their goods. You can use this information for business planning and management purposes and reduce its risk. Since futures contracts are not regulated, they are also private. Buyers and sellers have the freedom to beat any prices they deem fair and acceptable, but are not required to pass that price on to third parties.