Pls do not handwritten for easy reading
Question:-
Discuss and analyze the pros and cons of using forward contracts versus futures contracts for hedging purpose
| FORWARDS: |
| PROS: |
| *The rate is certain and is inclusive of the dealer's fee. |
| *The hedging can be 100% and the maturity date can be |
| as one wants. This is possible because the contracts are |
| tailor made. |
| CONS: |
| *The contract has to be performed on the due date. |
| *One cannot take advantage of price movements after the |
| contract is entered into. |
| *Counterparty risk of non performance is present. |
| FUTURES: |
| *One can exit from the futures contract by entering into a |
| reverse transaction for the same amount of the underlying. |
| *Counterparty risk of non performance is absent as futures |
| are managed by recognized stock exchanges. |
| *Better price determination is there as the transactions are |
| continuously entered into by different parties on the |
| futures exchange. |
| *Rates are transparent. |
| CONS: |
| *Being standardized contracts in terms of amounts/numbers |
| it is almost not possible to have exact 100% hedging. Mostly |
| there would be overhedging or underhedging. |
| *Constracts are subject to initial and maintenance margins |
| and one may be called upon to make up the maintenance |
| margin due to marking to market. |
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