Advantages of Forward Contracts – Customization & Hedging
Futures are standardized ($1000 lots). But what if I want to hedge exactly $953.50? I need a Forward.
1. Key Advantages
1. Customization"Tailor-made for date, amount, and asset quality."
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2. Privacy"Terms are secret between two parties (unlike Exchange data)."
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3. Complete Hedge"Since amount matches exactly, there is zero residual risk."
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4. No Margin Calls"Usually involves credit lines, so no daily cash hassle."
2. Comparison: Why Forward > Future for Corporates?
- Scenario: Infosys expects to receive $1,234,567 on 13th Feb.
- Futures: Standard lot is $1,000. Expiry is last Thursday. (Mismatched).
- Forward: Infosys calls CitiBank and books a Forward for exactly $1,234,567 on 13th Feb.
- Result: Perfect Hedge.
3. Exam Notes: Writing the Answer
Question: "Discuss the advantages of Forward Contracts." (5 Marks)
Answering Strategy:
- Keyword: Customization (Write this first).
- Privacy: Mention that hedge funds prefer this to keep strategies secret.
- Delivery: Good for those who actually want the asset (Importers).
Summary
- Bespoke: Forwards are like "Tailored Suits". Futures are "Ready-made Garments".
- Volume: The Forward market (Forex) is actually larger than the Futures market in volume!
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 4
1. The biggest advantage of Forward Contracts is: