Ábidos Forward contracts are a popular financial instrument used by businesses to hedge against future price movements. This type of contract is an agreement between two parties to buy or sell an asset at a predetermined price and date in the future.
One of the essential features of forward contracts is that they are settled daily. This means that the parties involved in the contract make daily payments to account for the changes in the value of the underlying asset.
For example, let`s say a business agrees to buy 1,000 barrels of crude oil from a supplier at $50 per barrel in six months. The current market price of crude oil is $55 per barrel. The business is concerned that the price of crude oil may rise over the next six months, making it more expensive to purchase the 1,000 barrels.
To hedge against this risk, the business enters into a forward contract with the supplier. The contract states that the business will buy 1,000 barrels of crude oil at $50 per barrel in six months. This allows the business to lock in the price of crude oil, protecting them from any future price increases.
However, because the market price of crude oil may change daily, the parties involved in the forward contract need to make daily payments to adjust for these changes. If the current market price of crude oil is now $52 per barrel, the business would need to pay the supplier $2,000 ($2 per barrel increase x 1,000 barrels) to keep the forward contract current.
On the other hand, if the current market price of crude oil is now $48 per barrel, the supplier would need to pay the business $2,000 ($2 per barrel decrease x 1,000 barrels) to keep the forward contract current.
Settling forward contracts daily mitigates any risk associated with not having to adjust for fluctuations in market prices. It ensures that both parties are protected against any market volatility and that the contract stays up-to-date with the current value of the underlying asset.
In conclusion, forward contracts are an important financial tool used by businesses to manage risk effectively. The daily settlement feature of these contracts ensures that both parties are protected against market volatility and that the contract is current with the underlying asset`s value. For businesses looking to hedge against price movements, forward contracts are an excellent option to consider.