RISK

MANAGEMENT:
FUTURE &
FORWARD
Presented by :
1. Chai Pui Gi (141222127)
2. Ang Ming Siang (141222121)
3. Saw Sze Hui (141222278)
4. Lim Kai Sim (141222178)
5. Ng Li Wen (141222221)
FORWARD CONTRACT
A forward contract is a private agreement
between two parties to buy or sell an asset
(which can be of any kind) at a pre-agreed
future point in time at a specified price.
Customized to customer needs.
Usually no initial payment required.
Usually used for hedging.
EXAMPLE OF FORWARD
CONTRACT
An IT company exports its services to US and hence earns its
revenue in Dollars.
If it knows it would receive a payment of $1 million in six
months time, it cannot be sure as to what would be the Rupee
value of this $1 million after six months.
Assuming that the current rate is Rs 43/$, the value as per current
rate would be Rs 43 million.
Now suppose the actual foreign exchange rate after six months is
Rs 37/$ and hence the company receives Rs 37 million which is
less by almost 14% due to the current value.
In the reverse scenario of rupee depreciating towards the dollar, a
rate of Rs 45/$ would lead to a gain of Rs 2 million.
Hence, the company is exposed to currency risk.
To hedge this risk, the company may sell dollar forward.
For example, it may enter into an agreement to sell $1 million
after 6 months at a rate of Rs 43/$. Note that it satisfies all the
conditions of a forward contract.
FUTURE CONTRACT
Futures contracts give the buyer an obligation to
purchase an asset (and the seller an obligation to
sell an asset) at a set price at a future point in
time.
A standardized forward contracts traded on
regulated exchanges.
Standardization:-
-quantity of underlying
-delivery dates and procedure
-price quotes
EXAMPLE OF FUTURE
CONTRACT
Jason has agreed to buy 1 lot (250 shares) of Reliance
Industries on 1 May 2017 at RM 200 per share. Hence;
The underlying is the shares of Reliance Industries
The quantity is 1 lot, which is 250 shares
The expiry date is 1st May 2017 and the pre-determined
price is RM 200
If the actual price of Reliance is RM 300 on the
settlement day (1st May), Jason buys 250 shares at the
contracted price of RM 200 and may sell at the market
price of RM 300. Then, Jason able to gain RM 100 per
share.
On the other hand, if the price falls to RM 150, then
Jason will loses RM 50 per share.
SIMILARITY OF FUTURE AND
FORWARD CONTRACT
Both are derivative securities for future
delivery/receipt.
Both are used to hedge currency risk,
interest rate risk or commodity price risk.
Both are used to accomplish the same goal
of risk management.
 DIFFERENCES OF FUTURE AND
FORWARD
Aspect Forward Future
Transaction Private Transaction Do not have private
Method transaction
Futures contracts are
reported to the future's
exchange, the clearing
house and at least one
regulatory agency.
The price is recorded
and available from
pricing services.
 DIFFERENCES OF FUTURE AND
FORWARD
Aspec
Forward Future
t
Market Forward contracts are Futures contracts are
regulation traded over-the-counter, conducted by Futures
meaning that they are market regulations.
not regulated. This also Futures contracts trading
opens up many more is regulated by the
risks to the parties Commodities and Futures
involved such as lack of Trading Commission,
liquidity or being unable which ensures pre and
to find the right buyer or post trade transparency
seller at a price you are and enforce other
looking for. regulatory requirements
on a exchange or a broker
that wants to engage in
the futures trading.
 DIFFERENCES OF FUTURE AND
FORWARD
Aspect Forward Future
Institutional Contracting Clearing House
Guarantee
parties
 DIFFERENCES OF FUTURE AND
FORWARD (CONT)
ASPECT FORWARD FUTURE
Risk High Low

Guarantee No guarantee Have guarantee

Contract As per terms of Predetermined

Maturity contract date
EXPIRY DATE
Forward
is the last day that an options
or futures contract is valid.
Example: The expiration date
is the agreed date where the
agreement between 2
counterparties was made.
is the time andFuture
the day that a
particular delivery month of a
futures contract stops trading, as well
as the final settlement price for that
contract.
Example: The expiration date for
listed stock options in the United
States is normally the third Friday of
the contract month, which is the
month when the contract expires.
However, when that Friday falls on a
holiday, the expiration date is on the
Thursday immediately before the
third Friday. Once an options or
futures contract passes its expiration
date, the contract is invalid. The last
day to trade equity options is the
Friday prior to expiry.
METHOD OF TERMINATION
OppositeForward
contract with same Future
or different counterparty.
Counterparty risk remains
while terminating with
different counterparty.
settlement of the contract Opposite contract on the exchange.
occurs at the end of the Marked-to-market daily, which means
that daily changes are settled day by day
contract.
until the end of the contract.
Example: The buyer agrees
to purchase the underlying
asset at a later date or at the
expiration date at a price
that is agreed to at the
beginning of the transaction.
CONTRACT SIZE
Forward
Forward contracts are not standardized, meaning the
terms of the quantity, quality of the asset and other
factors are negotiated on a contract basis.
A contract size is the deliverable
quantity ofFuture
commodities or
financial instruments underlying
futures and option contracts that
are traded on an exchange.
The contract size is standardized
for such futures and options
contracts, and uses to determine
the dollar value of a unit move in
the underlying commodity or
instrument.
Example: Contract size of wheat
futures is 5000 bushels. This means
that a single wheat futures contract
covers the trading of 5000 bushels
of wheat. This means that by
trading a single wheat futures
contract, you are trading the price
movement of 5000 bushels of wheat
at once.
MARKET
Forward
Primary market only.
Forward contracts are traded
Over-the-Counter(OTC) where
the terms of the contract can be
customized as per the needs of
the parties concerned.
Future
Primary & secondary
market
The highly standardized
nature of futures contracts
makes it possible for them to
be traded in a secondary
market.
The existence of an active
secondary market means
that if at anytime a
participant in a futures
contract wishes to transfer
his obligation to another
party, he can do so by selling
it to another willing party in
the futures market.
 THE FUTURE EXCHANGE DEVELOPED A
CLEARING HOUSE WHICH RECORDS
CLEARING HOUSE (FUTURE
EVERY TRANSACTION, FACILITATE
CONTRACT)
AND REGULATE THE DELIVERY OF
GOODS AND SETTLE ALL TRADING
TRANSACTIONS.
IT ASSUMES A ROLE IN A WAY THAT
THE SELLER HAS SOLD THE
CONTRACT TO THE CLEARING HOUSE
AND THE BUYER IS PURCHASING THE
CONTRACT FROM THE CLEARING
HOUSE. THE NET EFFECT IS THAT THE
NUMBER OF CONTRACT BOUGHT AND
SOLD ARE SAME.
ROLE OF CLEARING HOUSE
1. guarantee for all the transactions
2. It ensures that all parties adhere to the system and
procedures so that various parties in the market can do
trading smoothly which in turn leads to more confidence
of the players on the markets and hence it increases
liquidity in the market.
3. It ensures a proper risk management system in place by
stipulating that margin is maintained which is of two
types initial and maintenance margin
4. It ensures that delivery of the underlying asset is
consistent in terms of quality, quantity, size, in other
words all contracts are standardized.
EXAMPLE OF CLEARING HOUSE
For example, if a company wanted to purchase a
futures contract for wheat from a foreign party,
they would need to contact a clearing house,
which will use the international clearing system
to find another party. The other party, who will
assume the opposite position (in this case, the
one who is looking to sell the wheat contract) in
the futures contract, will have also contacted a
clearing house in their respective country, who
will also use the international clearing system.
ADVANTAGES &
DISADVANTAGES OF
FORWARD CONTRACT
o Advantages:
they are very flexible and can be customized to

the needs of the parties

o Disadvantages:
no liquid market, no secondary market

problem in price fixing. The party who has better

negotiating power may dictate an unfair price.

high default risk. One party may default(not fulfil

future obligation agreed upon earlier), resulting in

losses for the other party (counterparty risk)
requires actual delivery to complete the contract
ADVANTAGES &
DISADVANTAGES OF
FUTURES CONTRACT
Advantages:
1. Easy liquidation
2. Well organized and stable market (no risk of default)
3. No credit risk
.Disadvantages:

1. Limited to few currencies

2. Limited dates of delivery
3. Rigid contract sizes
THANK YOU