Forwards

I am a farmer. I expect to produce 5000 kgs of Cotton by 31-Dec-2020

The current price (01-Dec-2020) of Cotton is Rs 19750 per Bale (per 170 kg)
But I fear the prices may fall. What do I do?

I go to Forward market - search for Derivatives contract and take a position

1

Forward prices for Cotton are going at Rs 19880 per Bale (per 170 kg)

2 What position do I take in Forwards contract?

Short position in forward contract

3 What will be my payoff from Forwards Contract for a Hedger?

Physical Settlement
Spot Price /Market Price Payoff from
on 31-Dec-2020 Forward Contract
16000 19880
17000 19880
18000 19880
19000 19880
20000 19880
21000 19880
22000 19880

Cash Settlement
Spot Price /Market Price Payoff from Payoff by selling in
on 31-Dec-2020 Forward Contract market
16000 3880 16000
17000 2880 17000
18000 1880 18000
19000 880 19000
20000 -120 20000
21000 -1120 21000
22000 -2120 22000
Speculator's Payoff

4 Draw Hedger's payoffs on a graph

25000

20000

15000

5 What will be payoffs for a Speculator? 10000

5000

0
15000 16000 17000 18000 19000 20000 21000 22000
-5000
 15000

10000

5000

0
15000 16000 17000 18000 19000 20000 21000 22000
-5000
6 Draw Speculator's payoffs on a graph
 Total Payoff
(Derivative + Asset)
19880
19880
19880
19880
19880
19880
19880
Hedger's Payoff

00 19000 20000 21000 22000 23000

00 19000 20000 21000 22000 23000
Current exchange rate Rs/$ 75
Rs
I have imported goods and have to pay $ 10000 after 3 months

If Rs/$ becomes higher than 75 Rs Depreciates / Dollar Appreciate

I will be happy / or sad?

If Rs/$ becomes less than 75 Rs Appreciates / Dollar Depreciate

I will be happy / or sad?

Thus business is exposed to fluctuation in currency rate

3 month forward in USD is going at Rs 77

SHOW
A How do I use Forwards to hedge my risk?
B Show Hedger's & Speculator's Payoffs of Forwards hedge if the USD price after 3 months is Rs 70, 72, 80, 85, assu
C Plot a graph showing Payoff for Hedger and Speculator

A I take Long position in USD Forwards

Cash Settlement
Spot price (Market Contacted Price Payoff from Forward Buy from Final
price after 3 months) Market at Payoff

70 77 -7 -70 -77
72 77 -5 -72 -77
80 77 3 -80 -77
85 77 8 -85 -77
Speculator's Payoff Hedger's
Payoff

20
0
68 70 72 74 76 78 80 82 84 86
-20
-40
-60
-80
-100
 750,000.00

Rs Depreciates / Dollar Appreciates

Rs Appreciates / Dollar Depreciates

r 3 months is Rs 70, 72, 80, 85, assuming Cash Settlement

Today is 1st Dec 2020
RIL shares are currently quoted at Rs 1954 per share
I want to buy shares of Reliance Industries Ltd (RIL)
But cannot buy today as don't have enough money to invest
However I will get my Fixed Deposit of Rs 50,000 getting matured in Jan 2021
I plan to invest that money in shares of RIL
Jan Forward of RIL is going at Rs 1968

I fear the prices of RIL shares will go up

If prices go down, I am happy
But if prices go up, I am unhappy

What do I do?

SHOW
A How do I use Forwards to hedge my risk? What position will I take in Forwards?
B Show Hedger's & Speculator's Payoffs for Forwards hedge if the price in Jan 2021 are 1600, 1800, 2000, 2200,
C Plot a graph showing Payoff for Hedger and Speculator
are 1600, 1800, 2000, 2200, assuming Cash Settlement