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Forward Contracts
As noted previously, the primary purpose of derivatives is for risk management. Although the uses of forward contracts are covered in depth later in the curriculum, there are a few things to note here about the purposes of forward contracts. It should be apparent that locking in the future buying or selling price of an underlying asset can be extremely attractive for some parties. For example, an airline anticipating the purchase of jet fuel at a later date can enter into a forward contract to buy the fuel at a price agreed upon when the contract is initiated. In so doing, the airline has hedged its cost of fuel. Thus, forward contracts can be structured to create a perfect hedge, providing an assurance that the underlying asset can be bought or sold at a price known when the contract is initiated. Likewise, speculators, who ultimately assume the risk laid off by hedgers, can make bets on the direction of the underlying asset without having to invest the money to purchase the asset itself.
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