Forwards Flashcards
Largest market in Forward market:
Forward Foreign exchange market
Spot Market
Also called cash market.
Refers to transactions or deals that are settled at the earliest opportunity possible.
Derivatives market
Deals settled in future at prices determined now.
Spot deal
A contract between buyer and seller, undertaken on T+0, for the delivery of a security by the seller to the buyer and payment by the buyer to the seller in order to complete settlement of the deal at time T+0 or T+ a few days, depending on convenience.
Forward
A contract between a buyer and a seller that obliges the seller to deliver, and the buyer to accept delivery of, an agreed quantity and quality of an asset at a specified price (now) on a stipulated date in the future.
Advantages of forward markets
- Flexibility with regards to delivery dates.
- Flexibility with regards to size of contract
5 Disadvantages of forward markets
- The transaction rests on the integrity of the two parties.
- Both parties are ‘locked in’ to the deal for the duration of the transaction.
- Delivery of the underlying asset took place.
- The quality of the asset may be different than what is expected.
- Transaction costs are high.
3 Forward contract markets that are found in the debt market are:
- Forward interest rate contract
- Repurchase agreements
- Forward rate agreements
Forward interest rate contract (FIRC)
The sale of a debt instrument on a pre-specified future date at a pre-specified rate of interest.
Repurchase Agreement (Repo)
A contractual transaction in terms of which an existing security is sold at its market value (or lower) at an agreed rate of interest, coupled with an agreement to be repurchase the same security on a specified, or unspecified, date.
The 6 key features of a repurchase agreement
- Repos are structured as outright sales and repurchases.
- Full legal title to securities and cash are transferred.
- The buyer of the repo has an obligation to return equivalent securities.
- There is provision for initial margin and top-up margin.
- The equivalent of the coupon received from the issuer of the security is paid to the seller on the same day.
- Legal title to collateral is robust, which overcomes doubts when an event of default occurs.
Open Repos
The buyer and the seller have the right to terminate the agreement at any time.
No maturity date is specified.
Rate is usually a floating rate.
2 Types of repurchase agreement
- Open Repurchase agreement
- Fixed Term repurchase agreement
Fixed Term Repurchase Agreement
A repurchase agreements where the rate and the term are agreed at the outset of the agreement. The term of repos usually range from a day to a few months.
Why does the Reserve bank require banks to report repos on their balance sheet?
It is a method through which a bank can acquire funding.
Forward Rate Agreement
An agreement that enables a user to hedge itself against unfavorable movements in interest rates by fixing a rate on a notional amount that is (usually) of the same size and term as its exposure that starts sometime in the future.
Type of forward in the equity market:
Outright forward
Outright Forward
The sale of equity at some date in the future at a price agreed at the time of doing the deal
Foreign exchange
Deposits and securities in a currency other than the domestic currency, and an exchange rate is an expression of units of a currency in terms of one unit of another currency.
4 Types of forwards in the foreign exchange market:
- Outright forwards
- Foreign exchange swaps
- Forward-forwards
- Time options