Forward Contract is an agreement between two parties, called counterparties

Ø Derivatives are instruments that derive their value and payoff from another
asset, called underlying asset. Derivatives include options, forward contracts,
futures contracts and swaps. Investors, including firms, are risk averse. They
aim at reducing risk by hedging through derivatives.
Ø Hedging helps to (i) reduce costs of financial distress, (ii) isolate the effects of
changes in external factor like interest rates and foreign exchange rates on
profitability, and (iii) allow managers to focus on improving operating efficiency
rather worrying about changes in factors on which they have no control.
Ø Forward Contract is an agreement between two parties, called counterparties,
to buy and sell an asset at a future date at a price agreed upon today. There is
no immediate flow of cash. Cash is paid or received on the due date. Forward
contracts are obligations. They are not traded on organised exchanges.
Ø Futures Contract is like a forward contract. But, unlike forward contracts,
futures contracts are traded on organised exchanges. Thus, they are liquid. Yet
another feature of futures contract is that they are marked to market. Prices
differences every day are settled through the exchange clearing house. The
clearinghouse pays to the buyer if the price of a futures contract increases on aparticular day. The seller pays money to the clearing house. The reverse will
happen if the prices decrease.
Ø Swaps are arrangements to exchange cash flows over time.
Ø Currency Swap The agreement provides for exchanging payments
denominated in one currency for payments in another currency over a period of
time.
Ø Interest Rate Swap one type of interest payments, say, fixed-rate payments, is
exchanged for another, interest payments, say, floating-rate payments. The

floating interest rates may be tied to LIBOR.