Forward Contract - Hindi - YouTube

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Namaskar, my name is Mukul and welcome to Asset Yogi.

Friends in this video we will understand the forward contract in detail

The forward contract is a kind of financial derivative.

We understood the basics of financial derivatives in the previous video

If you haven't seen that video

So I would request you to watch that video and you will find the link below in the description.

Because in it you will at least understand all things at the foundation level of financial derivatives.

In the previous video, we also saw that there are 4 types of financial derivatives.

Forwards, futures, options, swaps

So in this video, we are going to understand forwards in detail.

With a forward contract price risk is reduced.

I will give you an example of this.

For example, a farmer who grows wheat.

And let's say he sells all his wheat to a food processing company.

So both the parties have price risks.

Price is a game of demand and supply.

If the price goes too low in any year, the farmer may suffer a loss.

And some year if the price goes too high

So the food processing company may endure loss

In such a situation, both parties can sign a contracts

where can fix their price

And you can reduce your risk.

It is called a forward contract.

In this video we are going to know how it works, so you must watch this video till the end.

Many people had requested this video.

We will cover this on the blackboard.

Let's go straight to the blackboard.

Music

Let's take an example.

Suppose this is a farmer, Mohan.

He grows a hundred bales of cotton on his farm.

On the other hand, there is a textile factory

By the name Ram Textiles.

Their requirement is 1000 balls of cotton.

With 10 farms like you Mohan, they fulfil their cotton balls requirement.

The problem here is that the price of cotton always goes up and down

Price may be different every year

There has been a lot of variation in the last few years

In cotton prices.

Let's say the price was ₹ 15,000 in the first year.

After that ₹ 20,000 per bale

1 bale = 170 kg,

the price per bale is written in rupees here

In the second year, it was ₹20,000

In the third year, it became 17,000-18,000

Then in the fourth year, it increased very much all of a sudden.

It reached 30,000.

The interesting thing here is that here we are taking the value of ₹ 15,000.

Mohan starts getting loss

It costs Mohan 16,000-17000,

Mohan cannot sell cotton below this.

On that, he has to bear the loss.

So he had to bear high losses this year.

Now if we talk about Ram Textile

As the cost goes up from 25000.

So Ram Textile has to bear the loss.

because suppose cotton per bale cost them ₹ 30,000

and they also have to bear the rest of their production cost

So they start getting loss on t-shirts or other products that they manufacture in their textiles.

So Ram Textiles and Mohan agree.

They say "let us sign a contract".

We fix prices for the coming years.

So that neither Mohan has to bear the loss.

nor Ram Textiles

So it is written that,

Ram textile agrees to buy and Mohan agrees to sell 100 bales of cotton

at rupees 20,000 per bale at the time of harvest

So both these people fix their prices for coming years

Let's say they sign a forward contract for the next 3 to 5years.

So here the advantage of both is that the price risk of both is reduced.

We call it hedging.

Whenever the price is going above ₹25000-₹30000.

So Mohan will be very happy that he is making a huge profit

Ram Textile will be happy when the price will be 15,000

Then their profits will increase.

But when the company incurs a loss

so at that time, the share price of the textile company will fall drastically.

They may have a bad credit history,

If Mohan has to bear the loss, he may be out of business.

See any company or any individual

can make less profit but

But incurring a loss is a big deal.

That's why both of them reduce their price risk by entering into a contract.

So this type of contract we call forward contract.

where quantity is fixed

Any commodity or an under-line asset.

How much will it sell at what price?

And at what time will it be sold?

So in the coming time, what quantity is being bought or sold at what price.

That thing is written in this contract.

So we understood what a forward contract is. We understood the basics.

But it also has some risks.

The biggest risk is the defaulter risk of contractor parties.

Suppose if Mohan didn't even deliver 100 bales of cotton

So what will Ram Textiles do?

Suppose if they delivered and Ram Textile refused to pay.

They said that we will give you the market price only.

We don't want to give you ₹20,000.

Let's say the rate becomes ₹15000

And Ram Textile says that we will give you only ₹ 15000.

We are not giving according to ₹20000

So there is a counterparty risk

The two parties who have come into the contract will have to go straight to court.

There is no immediate settlement for them.

The second risk is, Forward contracts are not traded on exchange

So you cannot sell this contract to any third party.

Both these problems will be solved in the futures.

We will talk about the futures in an upcoming video.

In which more sophistication comes.

If you trade forward contracts on the exchange.

So it becomes the futures

We will talk about the futures in the next video.

We understood the forward contract, Now let us see how it is settled.

Let's say in the first year of the contract, that is in the fifth year.

Here the market price was ₹ 25,000 per bale.

Where we get the actual price of rupees 25000.

But the contract price they have signed at ₹ 20,000.

How will the delivery be accomplished

One way settlement can be done is by delivery.

Delivery means 100 bales of cotton

Reached to Ram Textile.

Ram Textiles gave the money based on 20,000 per bale.

then what will be the total amount, they paid 20,00,000 rupees.

And he has delivered hundreds of bales of cotton.

what is the second option?

There will be no delivery here and these 20,00,000 rupees will not be given.

Now see what will happen here? Cash settlement can be done

This difference is ₹ 5000 per bale.

so what will happen here now

Mohan will say that I don't have bales of cotton right now.

Take delivery from someone else.

buy from the market

But i can pay you its difference

So what will happen in the cash settlement

Mohan will give ₹ 5,00,000 based on 5,000 rupees per bale to Ram textiles

Delivery of cotton will not be done in this case.

These are the 2 ways of settlement.

I think I have covered all the basics of a forward contract

Forward contracts are signed very informally.

And you have to go to court for the settlement

If there is any kind of default

That is why futures are a better option.

You can deal in futures if you want to deal in commodities

And similarly, the rest of the commodities, shares

Or any underlying asset for that you can deal in Futures.

We will talk about this in the upcoming video.