CFA level 1 Study Notes Key concepts - Forward Market and Contracts

1. A forward contract specifies that the long will pay a certain amount at a specific future date to the short, who  will deliver a certain amount of an asset. Default risk is the risk that the other party to the contract won't perform at settlement, since typically no money changes hands at the initiation of the contract.
2. A cash settlement forward contract doesn't require actual delivery of the underlying asset, but a cash payment at the settlement date from one counterparty to the the other, based on the contract price and the market price of the asset at settlement.
3. Early termination of a forward contract can be accomplished by entering into a new forward contract with the opposite position, at the then-current expected future price. This early termination will fix the amount of the payment to be made or received at the settlement date. If this new forward is with a different counterpary than the original, there is credit or default risk to consider if either of the two counterparties fails in its obligation under contract.
4. An end user of a forward contract is most often a corporation hedging an existing risk. Forward dealers,large banks, or brokerages originate forward contracts and take long side in some contracts and the short side in others,profiting from the spread to compensate them for actual costs, bearing default risk, and any unhedged price risk.
5. An equity forward contract may be on a single stock, a customized portfolio, or a stock index, and removes uncertainty about equity at some future dat. The contract can be written on a total return basis to include dividends, but most are based solely on an index value. Index forwards settle in cash based on the notional amount, the percentage difference between the index level at settlement, and the index level specified in the contract.
6. Forward contracts in which bonds are the underlying asset may be quoted in terms of the discount on zero coupon bonds(T-bills) or in terms of the yield to maturity on coupon bonds. Forwards on corporate bonds must contain special provisions to deal with the possibility of default as well as any call or conversion features. Forward contracts may also be written on portfolio of fixed income securities or on bond indices.
7. Eurodollar time deposits are USD-denominated short-term deposits (similar to certificates of deposits) purchased outside the U.S. from large money center banks.
8. The London Interbank Offered Rate(LIBOR) is an international reference rate for Eurodollar deposits and is quoted fro 30 days, 60 days, 90 days, 180 days, or 360 days (1 -year ) terms. Euribor is the equivalent for short-term Euro-denominated deposits and for both, actual interest is based on the loan term as a percentage of a 360-day year.
9. Forward rate agreements (FRAs), although settled in cash, can be viewed as a forward contract for the long to get a loan from the short at a specific future date at a rate fixed in the contract. In fact, no loan is made and the contracts are settled in cash. They are described by the length of the contract and the term of the interest rate in the contract (e.g. 90-day LIBOR ). If rates rise, the long receives a payment at settlement and the short receives a payment if the specified rate falls to a level below the contract rate.
10. The payment at settlement on a FRAs is the present value of the difference in interest costs between a riskless loan at the market rate ( usually LIBOR or Euribor ) and one made at the rate specified in the contract. The difference in rates is multiplied by the notional amount of the contract to get the difference  in interest due at the end of the loan term, then discounted back to the settlement date at the market rate of interest.
11. Currency forward contract specify that one party will deliver a certain amount of one currency at the settlement date for a certain amount of another currency. Under a cash settlement options,a single cash payment is made based on the difference between the exchange rate fixed in the contract and the market determined exchange rate at the settlement date.