Article: A forward contract is an agreement between a buyer and a seller to deliver a commodity on a future date for a specified price. The value of the commodity on that future date is calculated using rational assumptions about rates of exchange. Farmers use forward contracts to eliminate risk for falling grain prices. Forward contracts are also used in transactions using foreign exchange in an effort to reduce the risk of losses due to changes in the exchange rates. A derivative is a security with a price that is based upon, or derived, from something else. Forward contracts are considered derivative financial instruments because the future value of the commodity is derived from other information about the commodity. The future value of the commodity for the forward contract is derived from the current market value, or spot price, and the risk-free rate of return. In investing, hedging means minimizing risk. In forward contracts, buyers and sellers attempt to minimize risk of losses by locking in prices for commodities in advance. Buyers lock in a price in hopes that they will end up paying less than the current market value of a commodity. Sellers hedge their risks with forward contracts in an attempt to protect themselves from falling prices.
What is a summary of what this article is about?
Understand the definition of a forward contract. Learn the meaning of derivatives. Learn the meaning of hedging.