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What is a forward contract and what are the advantages and disadvantages of a forward contract?
The advantages of forward contracts are as follows: 1) They can be matched against the time period of exposure as well as for the cash size of the exposure. 2) Forwards are tailor made and can be written for any amount and term. 3) It offers a complete hedge. 4) Forwards are over-the-counter products.
What is the purpose of forward contract?
A forward contract is a customized derivative contract obligating counterparties to buy (receive) or sell (deliver) an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly useful for hedging.
What are the types of forward contract?
Forward Contracts can broadly be classified as ‘Fixed Date Forward Contracts’ and ‘Option Forward Contracts’. In Fixed Date Forward Contracts, the buying/selling of foreign exchange takes place at a specified future date i.e. a fixed maturity date.
How do you account for forward exchange contracts?
Record a forward contract on the contract date on the balance sheet from the seller’s perspective. On the liability side of the equation, you would credit the Asset Obligation for the spot rate. Then, on the asset side of the equation, you would debit the Asset Receivable for the forward rate.
Can a forward contract be Cancelled?
Forward contract, either short term or long term contracts where extension is sought by the customers (or are rolled over) shall be cancelled (at T.T. Selling or Buying Rate as on the date of cancellation) and rebooked only at current rate of exchange.
Who benefits from a forward contract?
Forward contract advantages Gives your business certainty over the exchange rate irrespective of the prevailing spot rate on maturity. Helps a business protect its profit margins from foreign currency market downside.
What are the major drawbacks of a forward contract?
The disadvantages of forward contracts are:
- It requires tying up capital. There are no intermediate cash flows before settlement.
- It is subject to default risk.
- Contracts may be difficult to cancel.
- There may be difficult to find a counter-party.