Get Adobe Flash player

Cancellation of Forward Contract Example

Facebook Twitter Email

In the world of finance, a forward contract is a binding agreement between two parties to buy or sell an asset at a future date, at a price that is agreed upon at the time the contract is signed. These contracts are used to hedge against fluctuations in the price of an asset over time.

However, there may be instances where one of the parties wishes to cancel the forward contract before the agreed-upon date. In this article, we`ll explore an example of the cancellation of a forward contract and the implications that follow.

Let`s say that a company, ABC Corp, enters into a forward contract with XYZ Inc to buy 1,000 shares of a particular stock at $100 per share on a future date. This contract is signed on January 1, 2021, with the agreed-upon delivery date of December 31, 2021.

As the year progresses, the stock price of the company in question begins to fluctuate. By December, the price has increased to $120 per share, meaning that ABC Corp would have to pay $120,000 to buy the 1,000 shares they contracted for.

However, due to unforeseen circumstances, ABC Corp can no longer afford to pay the agreed-upon price for the stock. In this situation, they may approach XYZ Inc to request a cancellation of the contract.

If XYZ Inc agrees to cancel the contract, several implications follow. Firstly, ABC Corp would need to pay a cancellation fee to compensate XYZ Inc for any financial loss they may have incurred due to the cancellation. This fee would be determined by various factors, such as the current market price of the stock and the remaining time until the delivery date.

Secondly, the cancellation of the contract would also have tax implications for both parties. Any gains or losses that either party may have realized from the contract would need to be reported to relevant authorities for tax purposes.

In conclusion, the cancellation of a forward contract can have significant financial and tax implications for both parties involved. Therefore, it is essential to carefully consider all potential risks and benefits before entering into such agreements.

Facebook Twitter Email

Comments are closed.