What are Deliverable Forwards? Components, Types & Trends

Deliverable forwards are essentially agreements between two parties to buy or sell an asset at a specified future date for a price agreed upon today. Unlike futures contracts, which are standardized and traded on exchanges, deliverable forwards are tailored to the specific needs of the parties involved. This customization allows for greater flexibility, but it also introduces certain risks, particularly credit risk.

Understanding the components of deliverable forwards is crucial for anyone looking to engage in these contracts. Here are the key elements:

• Underlying Asset: The asset that is being bought or sold in the contract. This can range from commodities to currencies to financial instruments.

• Contract Price: The agreed price at which the underlying asset will be exchanged at the contract’s maturity.

• Maturity Date: The specific date when the transaction will take place.

• Counterparty Risk: The risk that one party may default on the contract. This is a significant consideration, especially since deliverable forwards are not traded on exchanges.

• Settlement: The process of transferring the asset and payment at the maturity date.

There are several types of deliverable forwards, each serving different purposes:

• Currency Forwards: Used to hedge against foreign exchange risk by locking in exchange rates for future transactions.

• Commodity Forwards: Agreements to buy or sell physical commodities, such as oil or gold, at a future date.

• Interest Rate Forwards: Contracts that allow parties to lock in interest rates for future borrowing or lending.

• Equity Forwards: Agreements to buy or sell shares at a predetermined price, often used for hedging purposes.

The landscape of deliverable forwards is continuously evolving. Here are some of the latest trends:

• Increased Use of Technology: Financial technologies are streamlining the process of entering into deliverable forwards, making it easier to negotiate terms and execute trades.

• Focus on Risk Management: As market volatility increases, more investors are using deliverable forwards as a risk management tool to hedge against potential losses.

• Regulatory Changes: New regulations are being introduced to increase transparency and reduce counterparty risk associated with these contracts.

• Sustainability Considerations: There is a growing trend to incorporate sustainability criteria into forward contracts, especially in commodity trading.

Let us look at a few examples to illustrate how deliverable forwards work in practice:

• Example 1: A U.S. company expects to receive payments in euros in six months. To protect against potential depreciation of the euro, the company enters into a currency forward agreement to sell euros at a fixed exchange rate.

• Example 2: A farmer agrees to sell a specific quantity of corn to a food manufacturer at a set price for delivery in three months. This agreement helps the farmer lock in a price and protects against market fluctuations.

When dealing with deliverable forwards, several strategies can be employed:

• Hedging: Using deliverable forwards to mitigate risk associated with price fluctuations in the underlying asset.

• Speculation: Some investors may use forwards to speculate on the future price movements of an asset, aiming to profit from changes in price.

• Arbitrage: Taking advantage of price discrepancies in different markets through simultaneous buying and selling of forwards.

Deliverable forwards play a vital role in the financial landscape, offering flexibility and customization for hedging and investment strategies. Understanding their components, types and associated risks is essential for making informed decisions. As technology continues to evolve and market dynamics shift, staying updated on trends in deliverable forwards will be critical for both individual and institutional investors.