Fashion World Tips: Finance and Business

Senin, 19 Desember 2011

Forward Contracts

Forward contracts is a type of derivative financial instrument that occurs between 2 parties. The first party agrees to buy an asset from the second at a specified future date for a price specified immediately. These types of Forward contracts, unlike futures contracts, are not traded over any exchanges; they take place over-the-counter between 2 private parties. The mechanics of a forward contract are fairly simple, which is why these types of derivatives are popular as a hedge against risk and as speculative opportunities. Knowing how to account for forward contracts requires a basic understanding of the underlying mechanics and a few simple journal entries. Here's Tips On How to Account for Forward Contracts :

Determine the terms of the forward contract. A forward contract is a simple agreement that has 3 key characteristics. These characteristics are the spot rate, the forward rate, and the asset to be exchanged. The spot rate is the current market value for the asset in question. For example, consider a forward contract through which a farmer agrees to sell a quantity of grain to a wholesaler in the future at a price specified now. The spot rate is the price of that grain if it were to be sold immediately, rather than in the future. The forward rate is the agreed-upon future price in the contract. In the example above, imagine the grain is currently worth $10,000 (the spot rate). The contract may specify that the grain will be sold for $12,000 a year from now. This future price - $12,000 - is the forward rate. The third aspect of any forward contract is the asset to be exchanged. In the example above, the asset is a specified quantity of grain.
Record the journal entry for the establishment of the currency forward contract. When the contract is signed, no physical exchange takes place, but a journal entry must be made to recognize the signing. In the example above, the farmer debits Contract Receivable for $12,000 to recognize the amount of money collectible at the forward rate. The farmer credits Grain Obligation (or a similarly-named account) for $10,000 and Premium on Forward Contract ("PFC") for $2000. PFC is a contra-asset account that is associated with the Contract Receivable account. The wholesaler debits Grain Receivable for $10,000 (the spot rate) and PFC for $2000, and credits Contract Payable for $12,000. PFC represents a contra-liability account for the wholesaler.
Determine the market value of the asset as of the future and forward contracts maturation date. The journal entries needed upon maturation will vary based on the current market value of the asset in question. In this example, assume that after 1 year, the market value of the grain has risen to $11,000.
Record the journal entries upon the exchange of the asset. When the foreign exchange forward contracts matures, the asset is exchanged; in this case, the farmer sells the grain to the wholesaler at the forward rate ($12,000). Journal entries are needed to recognize this transaction. The farmer debits Cash for $12,000 (the actual amount received), and debits PFC for $2000 and Grain Obligation for $10,000 to close the account balances. The farmer credits Contract Receivable for $12,000 to close the account balance, credits Grain for $11,000 (the current market value), and credits Gain on Forward Contract for $1000 to record the $1000 gain recognized over the grain's market value. The wholesaler debits Contract Payable for $12,000 to close the balance, debits Grain for $11,000 (the market value), and debits Loss on Forward Contract for $1000. The wholesaler credits Cash for $12,000, and then credits Grain Receivable for $10,000 and PFC for $2000 to close the forward contracts.
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The Rule of 72

The rule of 72 is a handy rule used in finance to estimate quickly the number of years it takes to double a sum of capital given an annual interest rate, or to estimate the annual interest rate it takes to double a sum of money over a given number of years. The rule states that interest percentage times the number of years it takes to double a principal amount of money is approximately equal to 72. The Rule of 72 is applicable in exponential growth (as in compound interest) or in exponential decay. Here's Tips On How to Use the Rule of 72 :

The rule 72 is chosen as a convenient choice of numerator, since it has many small divisors: 1, 2, 3, 4, 6, 8, 9, and 12. It provides a good approximation for annual compounding, and for compounding at typical rates (from 6% to 10%). The approximations are less exact at higher interest rates.
To estimate doubling time for higher rates, adjust 72 rule by adding 1 for every 3 percentages greater than 8%. That is, T = [72 + (R - 8%)/3] / R. For example, if the interest rate is 32%, the time it takes to double a given amount of money is T = [72 + (32 - 8)/3] / 32 = 2.5 years. Note that 80 is used here instead of 72, which would have given 2.25 years for the doubling time.
For continuous compounding, 69.3 (or approximately 69) gives more accurate results, since ln(2) is approximately 69.3%, and R * T = ln(2), where R = growth (or decay) rate, T = the doubling (or halving) time, and ln(2) is the natural log of 2. 70 may also be used as an approximation for continuous or daily (which is close to continuous) compounding, for ease of calculation. These variations are known as rule of 69.3, rule of 69, or rule of 70. A similar accuracy adjustment for the rule of 69.3 is used for high rates with daily compounding: T = (69.3 + R/3) / R.
The Eckart-McHale second order rule, or E-M rule, gives a multiplicative correction to the Rule of 69.3 or 70 (but not 72), for better accuracy for higher interest rate ranges. To compute the E-M approximation, multiply the Rule of 69.3 (or 70) result by 200/(200-R), i.e., T = (69.3/R) * (200/(200-R)). For example, if the interest rate is 18%, the Rule of 69.3 says t = 3.85 years. The E-M Rule multiplies this by 200/(200-18), giving a doubling time of 4.23 years, which better approximates the actual doubling time 4.19 years at this rate. The third-order Padé approximant gives even better approximation, using the correction factor (600 + 4R) / (600 + R), i.e., T = (69.3/R) * ((600 + 4R) / (600 + R)). If the interest rate is 18%, the third-order Padé approximant gives T = 4.19 years.
Here is a table giving the number of years it takes to double any given amount of money at various interest rates, and comparing the approximation with various rules. Rate Actual Years rule of 72 calculator of 70 Rule of 69.3 E-M rule.
Felix's Corollary to the Rule of 72 is used to approximate the future value of an annuity (a series of regular payments). It states that the future value of an annuity whose percentage interest rate and number of payments multiply to be 72 can be approximated by multiplying the sum of the payments times 1.5. For example, 12 periodic payments of $1000 growing at 6% per period will be worth approximately $18,000 after the last period. This is an application of Felix's Corollary to the Rule of 72 since 6 (the percentage interest rate) times 12 (the number of payments) equals 72, so the value of the annuity approximates 1.5 times 12 times $1000.
Start reading and learning. Understand about that you are starting. Let the rule of 72 work for you, by starting saving now. At a growth rate of 8% per annum (the approximate rate of return in the stock market), you would double your money in 9 years (8 * 9 = 72), quadruple your money in 18 years, and have 16 times your money in 36 years.
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