MGFC10H3 Chapter 26: Chapter 26 Notes
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1: a forward contract is an agreement by two parties to sell an item for cash at a later date. The price is set at the time the. Firms hedge to reduce risk. agreement is signed. However, cash changes hands on the date of delivery. Forward contracts are generally not traded on organized exchanges. Futures contracts are also agreements for future delivery. They have certain advantages, such as liquidity, that forward contracts do not. An unusual feature of futures contracts is the mark-to-the-market convention. If the price of a futures contract falls on a particular day, every buyer of the contract must pay money to the clearinghouse. Every seller of the contract receives money from the clearinghouse. The mark-to-the-market convention prevents defaults on futures contracts: we divided hedges into two types: short hedges and long hedges. An individual or firm that sells a futures contract to reduce risk is instituting a short hedge.