Which of the following statement is are correct about Forward derivative 1 A forward contract i...........

Finance (Phase -I & II) Valuation of Securities

Which of the following statement is/are correct about Forward derivative ?

1.A forward contract is a contract between three parties to buy/ sell an asset on a specific date in the future at a determined price.

2.It is mostly used for hedging purposes (insuring against price risk).

only 1

only 2

Both 1 and 2

Neither 1 nor 2

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Explanation:

The basic types of derivatives are forward, futures, options, and swap.
Forward -
1. A forward contract is a contract between two parties to buy/ sell an asset on a specific date in the future at a pre-determinedprice.
2. It is mostly used for hedging purposes (insuring against price risk). For example: If you are a farmer producing onions and are concerned about the volatility in the prices of onions, you may enter into a forward contract. A contract to sell 100 kgs of onions to Arvind @ 40 per kg on1/1/2018.
3. The contract will hedge the farmer against the possible decline in prices. But, for a contract to make sense, it must be beneficial to both the parties. Arvind must have entered the contract as he thinks that the prices of onion will be greater than Rs.40 on 1/1/2018 and he will not incur any losses.