Forward price refers to the agreed upon purchasing price of a commodity or asset, scheduled for delivery at a specific future date. A forward contract contains forward price specifications as it connects the long counterpart (buyer) with the short counterpart (seller). The buyer and the seller agree to exchange the underlying commodity or asset while establishing a particular price for delivery on a specific future date.
How is the Forward Price Determined?
Forward price is calculated at the time of entering into the contract in such a way that it begins with its value as zero, meaning that neither party gains or loss at the outset. Various factors influence the forward price, such as the current market or spot price prevailing at the moment, the rate of interest, storage costs, and time left for delivery.
Why Forward Price is Important
Forward pricing is necessitated in price volatility hedging. For example, a farmer can use a forward contract to fix the raw material prices of crops so that revenues are not impacted by market price volatility. Similarly, manufacturers can lock raw material prices to control production cost-effectively.
Uses of Forward Price
Besides commodities, forward contracts are widely used in currency and interest rate markets for hedging and speculation.
Conclusion
Understanding forward price allows companies and investors to plan and control the risk in advance for future expenses, hence, it is a valuable tool in financial markets.
