Summary
Summary Financial instruments: derivatives
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Derivative: If value of financial instrument is based on the value of another financial instrument.
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lOMoARcPSD|837380Financial risk management - futures and forwards - F000738
A - Keuleneer
Valuation and Risk management (Universiteit Gent)
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Gedownload door Stefanie Deleu (stefaniedeleu46@hotmail.com)
, lOMoARcPSD|837380
FUTURES AND FORWARDS
Forwards
A forward is an obligation to buy or sell something (currency, bond) at the a future data but at a price
fixed today. An obligation to buy or sell something (= underlying asset) at a future date but at a price
(forward rate) fixed today (at the moment you buy/ sell). The price that you fix today in a forward is
not the spot price (price today for transactions that we also execute today), but the forward rate!!
Forward interest rate
Forward interest rate = (1 + SSP) * (1 + F) = (1 + SLP)
Forward currency rate
Currencies
• t0: 1$ = 1€
• 1 year Euribor = 300%
• 1 year Libor = 100%
What is at t0 the 1 year forward currency rate? 1$ = …€
Today (t0), you start with 0 money, you go to the bank and you borrow 1$. Then you know at t1 (1
year from now), you have to repay 2$ (1$ + 100% interest). But today, you can sell the 1% for 1 EUR,
at the end the end of the year, you’ll have 4 EUR (1 EUR + 300%). If at t0, you make an agreement
with a forward rate: 1$ = 0,50 EUR. So at t1 you can convert the 4 EURO into $8, but at t1 you have to
pay $2, so you have $6 left. Risk free profit. If the forward rate is $1 = 2 EUR, then you convert the 4
EUR into 2$ and you have nothing left.
When is the spot rate equal to the forward rate today?
Interest differential: difference in the level of the interest rate between the 2 currencies. If there is
no difference, then the spot rate will be equal to the forward rate.
You need to know the spot currency rate and the interest rates, then you can calculate the forward
currency rates.
Forward rate = fair rate if you agree today to a certain price for a future date. Fair rate today to fix
something that is going to happen in the future → NO PREMIUM. (= Termijncontract)
A forward contract is a private agreement between two parties giving 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.
The assets often traded in forward contracts include commodities like grain, precious metals,
electricity, oil, beef, orange juice, and natural gas, but foreign currencies and financial instruments
are also part of today's forward markets.
FRA’s: forward rate agreement
How it works/Example
If you plan to grow 500 bushels of wheat next year, you could sell your wheat for whatever the price
is when you harvest it, or you could lock in a price now by selling a forward contract that obligates
you to sell 500 bushels of wheat to, say, Kellogg after the harvest for a fixed price. By locking in the
price now, you eliminate the risk of falling wheat prices. On the other hand, if prices rise later, you
will get only what your contract entitles you to. If you are Kellogg, you might want to purchase a
forward contract to lock in prices and control your costs. However, you might end up overpaying or
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Gedownload door Stefanie Deleu (stefaniedeleu46@hotmail.com)
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