Nism Series 8 | chpter 3 : Introduction To Forwords And Futures Part-1 | NISM Certification

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Chapter 3: Introduction to Forwards and Futures
• Meaning of forward and futures contracts
• Terminology related to futures contracts
• Payoff for a futures contract
• Pricing of a futures contract
• Applications of a futures contract by speculators, hedgers and
arbitrageurs

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-+Introduction to forward contracts
A forward contract is an agreement made directly between two parties to buy or sell an
asset on a specific date in the future, at the terms decided today. Forwards are widely
used in commodities, foreign exchange, equity and interest rate markets.
Let us understand with the help of an example. What is the basic difference between cash
market and forwards? Assume that on May 11, 2023 you want to purchase gold from a
goldsmith. The market price for gold on this day is Rs. 62,130 for 10 grams of 24 carat gold
and the goldsmith agrees to sell you gold at this price. You pay him Rs. 62,130 for 10 grams
of gold and take delivery of the gold. This is a cash market transaction at a price (in this
case Rs. 62,130) referred to as spot price.
Now suppose you do not want delivery of the gold on May 11, 2023, but only after 1
month. The goldsmith quotes you Rs. 62,337 for 10 grams of gold. You agree to the
forward price for 10 grams of gold and go away. Here, in this example, you have “bought
a forward contract” or you are “long forward”, whereas the goldsmith has “sold a forward
contract” or he is “short forward”. There is no exchange of money or gold at this point of
time. After 1 month, you come back to the goldsmith pay him Rs. 62,337 and take 10
grams of gold from him. This is a forward, where both the parties are obliged to go
through with the contract irrespective of the value of the underlying asset (in this case
gold) at the time of delivery.
Essential features of a forward are:
• It is a contract between two parties (a bilateral contract).
• All terms of the contract like price, quantity and quality of underlying, delivery
terms like place, settlement procedure, etc. are fixed on the day of entering into
the contract.
In other words, forwards are bilateral over-the-counter (OTC) transactions where the
terms of the contract, such as price, quantity, quality, time and place are negotiated
between two parties to the contract. Any alteration in the terms of the contract is possible

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