Answer to Question #212814 in Financial Math for phs

Question

Explain the following terms with appropriate examples: (a) Equity forwards. (b) Currency forwards.

Answer 1

(a) Equity forwards

It is an agreement between two parties to buy a pre-specified number of an equity stock ( or portfolio or stock index) at a given price.

For instance, if an investor who holds 1,000 shares pf Google and wants to sell them after 60 days. Since there is uncertainty about the price of the stock after 60 days, the investor can enter into a forward contract to sell these stocks after 60 days at a price determined today. After 60 days, irrespective of what the market price of the stock is, the investor will investor will have to deliver the stock to the counterpart at the prefixed price.

(b) Currency forwards

An agreement between two parties to exchange a certain amount in currencies at a certain rate at a certain time.

For instance, an importer of goods from Europe needs to pay Euro after 90 days and can enter into a 90-day forward contract to buy Euro in order to reduce exchange rate risk.