Derivatives - End Users and Dealers

End users of forward contracts vary across a broad range of sectors. In general, end-users have specific risk management concerns that can be mitigated by an appropriate forward contract. However, because forward contracts are not found on a formal exchange, end-users must find a counterparty to their contracts. A dealer is used find a complimentary counterparty that can provide a financial transaction to solve the problem. The problem could be that the end user wants to reduce or eliminate risk or just wants to take a position on the way the market may move in the future. End users are typically corporations, nonprofit organizations and governments. Below are two examples of situations in which end-users can mitigate risk with forward contracts.

An engineering firm based in Rome, Italy, has a contract with an American company for six months of work. The Italian company is being paid in two installments: the first payment at the start of the contract and the final payment on the closing date of the contract. The Italian company arranges a closed forward contract for the final payment. This protects the company against currency fluctuations and establishes how much the company will receive in euros for its final payment. This allows the company to avoid losing revenue unexpectedly as a result of rate fluctuations.

An importer in Chicago is bringing in a line of ceramics from Spain. The stock is due to arrive in the U.S. in three shipments over the next two months. Because the importer will pay for each shipment on arrival, the importing company arranges for an open forward contract equal to the value of the entire order in euros. The open contract allows the importing company to make a series of payments by drawing down on the contract amount throughout the contract period. Thanks to the forward contract, the importer knows exactly how much it needs to pay for the shipment in U.S. dollars, rather than having this amount change due to rate fluctuations between the time it books the order and when the shipment arrives.

Farmers, manufacturers, importers and exporters are typical end-users who hedge their positions by buying or selling in the futures market to secure the future price of a commodity intended to be sold at a later date in the cash market.

Other market participants, however, do not aim to minimize risk but rather to benefit from the inherently risky nature of the futures market. These are the speculators, and they aim to profit from the very price change that hedgers are protecting themselves against. Hedgers want to minimize their risk no matter what they're investing in, while speculators want to increase their risk and maximize their profits. Unlike the hedger, the speculator does not actually seek to own the commodity in question. Rather, he or she will enter the market seeking profits by offsetting rising and declining prices through the buying and selling of contracts.

Dealer
A dealer helps facilitate the trading and structure of these transactions based on the end user's specific needs and goals. Dealers may take the other side of the trade for the end user or a dealer may find another counterparty that has the exact opposite needs of the end user. A dealer differs from an agent in that it takes ownership of the asset, and thereby is exposed to some risk. A dealer has ownership, even if only for an instant, between a purchase from one party and a sale to another party, and is thus compensated by the spread between the price paid and the price received.
Individuals or firms may act as either a broker or a dealer in separate transactions. This helps the dealer reduce the end user's risk from derivatives and may allow the dealer to earn additional revenue by buying and selling these contracts with his clientele. Dealers tend to be broker/dealers and/or large global banking institutions such as JP Morgan Chase, Citigroup and UBS Warburg to name a few of them.

Equity Forward Contracts
Related Articles
  1. Career Education & Resources

    How Hard are the CFA Exams?

    Learn about the difficulty of the CFA exams with a description of the tests, some statistics on pass rates and suggestions that can help you pass the exams.
  2. Professionals

    What it Takes to be a Financial Analyst

    A financial analyst researches companies and economic conditions to make business, sector and industry recommendations.
  3. Career Education & Resources

    Financial Analyst: Career Path & Qualifications

    Read about what it takes to become a financial analyst in a corporation or securities firm, and learn how far you can rise in the profession.
  4. Career Education & Resources

    Financial Planner: Career Path & Qualifications

    Learn what education and certifications you need to become a financial planner, as well as the future prospects and earnings potential for financial planners.
  5. Career Education & Resources

    Where to Find Non-Profit Finance Jobs

    The non-profit sector offers a stable selection of jobs for those who seek other types of fulfillment from their jobs than just purely financial.
  6. Career Education & Resources

    Portfolio Manager: Career Path & Qualifications

    Learn about the basic requirements for getting hired as a portfolio manager, and discover how most professionals in the field rise into the position.
  7. Your Practice

    4 Professional Associations Advisors Should Join

    These four professional organizations are among the most respected and well known in the industry.
  8. Professionals

    Equity Research: Career Path and Qualifications

    Find out what equity research analysts do on a day-to-day basis, and learn more about the typical career progression for these securities professionals.
  9. Professionals

    What's on the CFA Level II Exam?

    The Chartered Financial Analyst Level II exam is the second of three tests that CFA candidates must pass.
  10. Professionals

    Financial Data Analyst: Career Path & Qualifications

    Learn more about the career options available to financial data analysts, and determine whether the profession is a good match for you.
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
RELATED FAQS
  1. Do financial advisors work only in banks?

    While the majority of financial advisors work for financial institutions such as banks, a large proportion of them are self-employed ... Read Full Answer >>
  2. Can I use my IRA to pay for my college loans?

    If you are older than 59.5 and have been contributing to your IRA for more than five years, you may withdraw funds to pay ... Read Full Answer >>
  3. Can I use my 401(k) to pay for my college loans?

    If you are over 59.5, or separate from your plan-sponsoring employer after age 55, you are free to use your 401(k) to pay ... Read Full Answer >>
  4. What are the benefits of financial sampling?

    Financial sampling allows auditors to approximate the rate of error within financial statements. For accounting purposes, ... Read Full Answer >>
  5. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  6. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center