Can a forward contract be used for hedging?

A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging . A forward contract is a customizable derivative contract between two parties to buy or sell an asset at a specified price on a future date.

What is the difference between a forward contract and an option?

Though there are various types of forward agreements such as goods, commodities or assets, but the foreign currencies forwards have the largest trading market. In addition to this, forward contracts are very much similar to option in hedging risk. There is just a hairline difference between the two.

What is the payoff of a forward contract?

Forward Contract Payoff Diagram and Example The payoff of a forward contract is given by: Forward contract long position payoff: ST – K Forward contract short position payoff: K – ST Where: Kis the agreed-upon delivery price. STis the spot price of the underlying asset at maturity.

What is a forward contract settlement?

A forward contract settlement can occur on a cash or delivery basis. Forward contracts do not trade on a centralized exchange and are therefore regarded as over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher degree of default risk .