Forward Commitment
Categories: Derivatives
A forward commitment is a procrastinator’s contract: a contract between two parties (a buyer and a seller) that will be done at a future date. The contract lists what will be sold to whom, for how much, when payment will be complete, and when the goods will arrive on the buyer’s doorstep.
Forward commitments are used in lots of situations, like futures contracts and some types of derivative investments.
They aren’t about people not wanting to be last-minute...they’re about certainty. Forward commitments make both buyer and seller commit to the current price of whatever is being sold. If you were buying large quantities of a commodity that’s important for your business...like steel...then you’d be happy you made a forward commitment in the past when the news drops that steel tariffs will drive up steel prices. Because you locked in the old price, you’re not even breaking a sweat. Phew.
Related or Semi-related Video
Finance: What is Forward Pricing?12 Views
Finance a la shmoop what is forward pricing?
well open-ended mutual funds trade the shares within them all day long buy
orders sell orders that stuff but the price of a given share of that mutual [Mutual funds appear with share price]
fund does not in fact change every second of the trading day like the
shares do inside of it like its NAV price does not suddenly change every
minute too many complexities and too many
moving parts derived from a free computer in every bathroom era when
manual labor had to add numbers and figure out totals we just can't operate [Person jotting down numbers]
funds such that they adjust every second of the day especially when the larger
mutual funds can have literally thousands of investments in them well
the price of a share of a mutual fund is its net asset value and is derived by
adding up all the bid prices offered to buy a given security and then adding in
cash and accounting for any other special holdings like a private
company's not yet public and then taking a discount to them that's fair because
there's more risk when they're not public and traded in the market setting
a price on them every minute right all right and then once you have all that
totaled you divide by the number of shares outstanding of the mutual funds [NAV formula appears]
so if you put in an order at 10:37 a.m. to buy a thousand shares of a given [Man checks watch]
mutual fund the seller can't actually give you an exact price that's how you
want to buy that fund the close yesterday was $11.87 share in the market
today is flattish so it's highly likely that at the close of this day well the
price will be about 11.87 but who knows it might be eleven eighty nine it might
be eleven eighty four or somewhere else in that neighborhood so the fund has to
give you forward pricing such that you commit well about a thousand times about
11.87 or 11,870 dollars to buy
these thousand mutual fund shares but you won't get the exact total or bill I
guess until the market is closed and the totals have been you know totaled and [Bell rings and clock strikes 4pm]
then at that point you can become the proud new owner of a thousand shares of
the feeling is mutual fund so this situation revolves around the exact
act number of mutual funds shares method of buying meaning you want a thousand
shares of the mutual fund you want to pay $11.87 and you pay 11,870
dollars for the privilege okay [Man discussing purchasing of mutual fund]
the much more common way of buying shares in a mutual fund company is to
buy fractional shares and simply commit a dollar amount that's about what you
want to invest in the mutual fund like let's say you had about 12 grand that
you wanted to invest and that's it 12 grand so on that day you're actually
rooting for the NAV to go down the day that you actually buy the fund [Girl celebrating for NAV to decrease]
well why would you root for it to go down? well you don't own it yet if it
goes down you get the same shares cheaper right because the more it falls
the higher the number of shares at NAV of that mutual fund you're buying with
your 12 grand so if the nav closes at 11.87 and you're buying 12
grand worth well then you get twelve thousand dollars divided by 11.87
or one 1,011 shares right and there gets to be
fractionals in there as well if you really want to get technical that's [Man discussing fractionals]
forward pricing not to be confused with fast forward pricing which requires the
use of a remote control and two double-a batteries [Remote control and batteries appear]