Question

a Forward contract

i. When do we create the forward contract to buy foreign currency?

ii. When do we create the forward contract to sell foreign currency?

b. Futures contract

i. When do we create the futures contract to buy foreign currency?

ii. When do we create the futures contract to sell foreign currency?

Answer 1

Forward contract:

If investor has a exposure in particular currency and he is thinking that the value of the currency will fall in near future then he will buy the forward contract over the OTC market, he will buy forward contract because terms and conditions are not standardized. There is no initial margin requirement sometime which create counterparty risk to forward contracts.

If investor is thinking the value currency will fall in near future than he will be short on the forward contract. In that way he can hedge the risk of the currecy against the falling exchnage rate. There is no initial margin requirement sometime which create counterparty risk to forward contracts. It is not a standrdized contract.

Future Contract:

We use future same as forward in case of buy or sell but there is few differences which are as follows:

Future is standard contract thus delivery quantity,data and methods are mentioned.

It requires initial margin which reduce the counterparty risk in case of default.

It is traded on exchange that again reduce the counterparty risk in case of default.