Topic 11: Forwards and Futures

Question 1

What is a forward contract?

Answer 1

A contract entered into on a particular date to exchange a specific amount of a specific currency for a specific amount of another specific currency at defined future date.

Question 2

What is a forward rate?

Answer 2

The rate at which a forward contract swaps at, denoted F(d/f).

Question 3

What does f(d/f) denote?

Answer 3

The proportional difference of the forward rate from the spot rate.

Question 4

What is a futures contract?

Answer 4

A contract entered into on a specific date to buy or sell a specific amount of a specific currency at a specific rate on a future date.

Question 5

What are the differences between futures and forwards?

Answer 5

1. Forward contracts must be written and negociated. Futures are exchange traded.
2. Futures have a limited range, forwards are tailor made.
3. Futures are made with an exchange, forwards are made with another party.
4. Futures are market to market, fowards are settled at delivery.

Question 6

What does it mean to say that futures are market to market?

Answer 6

When you enter into a future contract you are required to make a deposit into a margin account. The broker computes your daily profit / loss compared to the spot rate, and settles it from your margin account. If that account depletes entirely, then you must top it up, or your account is closed.

Question 7

What are the limitations of forward contracts?

Answer 7

1. Requires a double coincidence of wants.
2. Default risk.
3. Lack of liquidity.

Question 8

Show when a forward contract ( to buy japanese yen) suffers a loss, and when it earns a profit relative to the spot rate.

Answer 8