Derivatives Trading Basics
by 5paisa Research Team Last Updated: 2022-06-15T18:25:33+05:30

Introduction

The forward market, also known as the forward exchange market, enables investors to identify an asset (read, underlying asset), predict its price on a future date, and enter into an agreement with the seller of the asset. Similarly, a seller uses the forward market to connect with a buyer and offer to sell an underlying asset at a pre-decided price on a future date. Unlike futures, the forward market is an Over-The-Counter market where two parties meet and enter into a formal agreement. 

The following sections describe the forward exchange market in detail and elucidate its benefits, features, and importance. 

What is Forward Market?

Forward market refers to an over-the-counter marketplace where sellers and buyers set the price of derivatives instruments tracking underlying assets for delivery on a future date. Although buyers and sellers use the forward market for trading a wide range of instruments, such as stocks, indices, commodities, interest rates, etc., the term is most commonly associated with the foreign exchange market. The forward market is generally accessed by large financial institutions, banks, and industries. 
 

What is the Forward Markets Commission?

The Forward Markets Commission (FMC) is a regulatory body for monitoring futures and commodities market in India. FMC is fully controlled by the Securities and Exchange Board of India (SEBI) under the Ministry of Finance. The Forward Markets Commission was established in 1953 and is headquartered in Mumbai, Maharashtra. 

FMC controls the regulatory side of the Indian forward market. Presently, five (5) national exchanges, including Multi Commodity Exchange (MCX), National Commodity and Derivatives Exchange (NCDEX), Indian Commodity Exchange Ltd (ICEX), National Multi Commodity Exchange (NMCE), and ACE Derivatives and Commodity Exchange, facilitates forward trading in over 110 commodities in India. Moreover, sixteen (16) other commodity exchanges regulate trades in many commodities specified in the Forward Contracts (Regulation) Act, 1952.
 

What Are The Various Types of Forward Contracts?

Generally, the forward market facilitates four types of forward trades:

1. Closed Outright Forward - Two parties fix the exchange rate based on the current spot rate and the premium

2. Flexible Forward - Two parties agree to exchange funds on or before the date of the contract maturity.

3. Long Dated Forward - These are like short-dated contracts with a distant maturity date.

4. Non-Deliverable Forward - Here, the instrument is not traded physically. Instead, the two parties agree to settle or pay the difference between the exchange rate and the spot price

What Are The Features of the Forward Market?

Since the forward exchange market is over-the-counter, the trades take place through broker-dealers. The buyers and sellers are referred to as 'Private Parties.' Unlike exchange-facilitated trades, such as futures and options, the private parties negotiate the contract terms and set the price in the forward market. Also, in the forward market, most transactions and trades are delivery-based.

What is the Importance of the Forward Market?

The forward market enables two parties to set the future price of an underlying asset. Forward contracts are primarily used as a hedging instrument against market uncertainties. The forward market is preferred by investors looking for customisation and not standardisation, as is the case with the futures and options market.

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