Terminvertrag

What Is Terminvertrag?

A Terminvertrag, commonly known as a forward contract in English, is a customized agreement between two parties to buy or sell an asset at a specified price on a future date. It is a fundamental type of derivative, a broader category of financial instrument whose value is derived from an underlying asset, rate, or index. Unlike standardized exchange-traded contracts, a Terminvertrag is typically traded over-the-counter (OTC), meaning it is a private transaction negotiated directly between the buyer and seller. This customization allows parties to tailor the contract's terms, including the asset, quantity, price, and delivery date, to their specific needs.

History and Origin

The concept of future delivery contracts, which are the precursors to modern Terminverträge and other derivatives, dates back centuries. Early forms emerged in agricultural markets where farmers and merchants sought to manage the uncertainty of future prices for crops. For instance, in 17th-century Amsterdam, forward and option contracts were already being traded for commodities like wheat and herring. The formalization of these arrangements into more structured agreements, though still largely private, laid the groundwork for the sophisticated derivatives markets seen today. The development of organized exchanges in the 19th century, such as the Chicago Board of Trade, further evolved these early forward contracts into what would become standardized futures contracts.,^9
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Key Takeaways

• A Terminvertrag is a private, customizable agreement to buy or sell an asset at a predetermined price on a future date.
• It falls under the category of derivatives and is primarily used for hedging or speculation.
• Unlike futures, Terminverträge are typically traded over-the-counter (OTC) and are not subject to daily marking-to-market.
• They carry counterparty risk because there is no central clearinghouse guaranteeing performance.
• The contract's terms, including the underlying asset, quantity, and price, are negotiated directly between the parties.

Formula and Calculation

The forward price ($F_0$) of a Terminvertrag for a non-dividend-paying stock can be calculated using the spot price ($S_0$), the risk-free interest rate ($r$), and the time to maturity ($T$ in years).

The formula is:

$F_0 = S_0 e^{rT}$

Where:

• (F_0) = Forward price at time 0
• (S_0) = Spot price of the underlying asset at time 0
• (e) = The base of the natural logarithm (approximately 2.71828)
• (r) = Risk-free interest rate (expressed as a decimal)
• (T) = Time to maturity of the contract (in years)

This formula assumes continuous compounding and no storage costs or dividends for the underlying asset. For assets with dividends or storage costs, the formula adjusts to account for these cash flows. The principle behind this calculation is to prevent arbitrage opportunities, ensuring that the forward price reflects the cost of holding the asset until the delivery date.

Interpreting the Terminvertrag

Interpreting a Terminvertrag involves understanding the agreed-upon price in relation to the current market price of the underlying asset. If the agreed forward price is higher than the current spot price, it suggests that market participants anticipate the underlying asset's price to rise by the delivery date, or it reflects the cost of financing the asset until then. Conversely, a lower forward price might indicate expectations of a price decline.

For parties entering a Terminvertrag, the primary interpretation often revolves around risk management. A buyer locking in a price is typically seeking to hedge against potential future price increases of an input cost, while a seller is hedging against potential future price decreases of an output. The difference between the contract's specified price and the spot price at settlement determines the profit or loss for each party.

Hypothetical Example

Consider an airline, Skyways, that anticipates needing 1 million gallons of jet fuel in six months. The current spot price for jet fuel is $3.00 per gallon. Fearing a price increase, Skyways enters into a Terminvertrag with an oil supplier, Global Energy.

• Underlying Asset: Jet fuel
• Quantity: 1 million gallons
• Delivery Date: Six months from now
• Forward Price: $3.10 per gallon

Six months later, on the delivery date:

• Scenario 1: Spot Price is $3.25 per gallon.

  • Skyways buys the fuel from Global Energy at the agreed $3.10 per gallon, saving $0.15 per gallon compared to the current spot price.
  • Total savings for Skyways: 1,000,000 gallons * ($3.25 - $3.10) = $150,000.
  • Global Energy sells at $3.10, missing out on the higher spot price, incurring a notional loss of $150,000 from the perspective of what they could have sold it for on the spot market. However, they locked in a price they deemed acceptable.

• Scenario 2: Spot Price is $2.90 per gallon.

  • Skyways buys the fuel from Global Energy at the agreed $3.10 per gallon, paying $0.20 per gallon more than the current spot price.
  • Total additional cost for Skyways: 1,000,000 gallons * ($3.10 - $2.90) = $200,000.
  • Global Energy sells at $3.10, benefiting from a higher price than the spot market, realizing a notional gain of $200,000.

This example illustrates how a Terminvertrag helps both parties manage price risk, providing certainty for future transactions, even if it means foregoing potential gains or incurring notional losses relative to the future spot price.

Practical Applications

Terminverträge are widely used across various sectors for risk management and financial planning:

• Currency Hedging: Multinational corporations use currency forwards (a type of Terminvertrag) to lock in exchange rates for future international transactions, protecting against adverse currency fluctuations. This is a common strategy for companies looking to manage currency risk., F⁷o⁶r example, a company expecting a large payment in a foreign currency in three months might sell that currency forward to convert it to its home currency at a known rate. This helps "shield profits from currency swings."
• ⁵ Commodity Price Management: Businesses dependent on raw materials (e.g., airlines needing jet fuel, food producers needing grains) use Terminverträge to fix the cost of future commodity purchases, thereby stabilizing their input costs. Conversely, producers of commodities can use them to lock in a selling price for their output.
• Interest Rate Management: Forward Rate Agreements (FRAs), a specific type of Terminvertrag, allow parties to lock in an interest rate for a future borrowing or lending period, hedging against interest rate volatility.
• Investment and Trading: While often used for hedging, Terminverträge can also be employed for speculation, where parties aim to profit from anticipating future price movements of an underlying asset. This can also involve arbitrage strategies, taking advantage of price discrepancies between different markets.

Limitations and Criticisms

Despite their utility, Terminverträge have several limitations and criticisms:

• Counterparty Risk: Because they are private, over-the-counter agreements, Terminverträge expose both parties to counterparty risk. This is the risk that the other party to the contract will default on their obligations. Unlike exchange-traded derivatives, there is no clearinghouse to guarantee the transaction, which can lead to significant losses if a counterparty fails. The 2008 financial crisis highlighted the "potential dangers of derivatives," especially those traded OTC, due to interconnectedness and opacity.,
• ⁴³Lack of Liquidity:** The customized nature of Terminverträge means they are often illiquid. It can be difficult to offset or exit a position before the delivery date because finding a willing third party to take on the exact same customized terms can be challenging. This contrasts sharply with the high liquidity of exchange-traded contracts.
• Lack of Standardization and Transparency: The absence of a central exchange and standardization makes it harder for regulators to oversee the market, potentially obscuring systemic risks. Following the 2008 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act aimed to increase transparency and reduce risk in the OTC derivatives markets by mandating reporting and, for some contracts, clearing and exchange execution.,
• ²D¹ifficulty in Valuation: The unique terms of each Terminvertrag can make their fair value difficult to ascertain, especially in illiquid markets, which can pose accounting and risk management challenges for financial institutions.

Terminvertrag vs. Futures Contract

While both Terminverträge (forward contracts) and futures contracts are agreements to buy or sell an asset at a future date for a predetermined price, key differences exist:

The fundamental distinction lies in their trading environment and the mechanisms for managing risk. Futures contracts benefit from the transparency and risk reduction offered by an exchange and clearinghouse, while Terminverträge offer unparalleled flexibility through direct negotiation.

FAQs

What is the primary purpose of a Terminvertrag?

The primary purpose of a Terminvertrag is to manage price risk by locking in a price for a future transaction. This allows businesses or investors to protect themselves against adverse price movements of an underlying asset, whether for an input cost or a future revenue stream.

Can individuals trade Terminverträge?

While theoretically possible, individuals typically do not directly trade Terminverträge due to their over-the-counter nature and the significant counterparty risk involved. Most forward contracts are negotiated between financial institutions and corporations. Individuals who wish to speculate on future prices usually opt for exchange-traded futures contracts or other more accessible derivatives.

How is a Terminvertrag different from an option?

A Terminvertrag obligates both parties to complete the transaction at the agreed price on the specified date. In contrast, an option contract gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. The option buyer pays a premium for this right, which is their maximum potential loss, whereas with a Terminvertrag, both parties have unlimited potential losses or gains based on the underlying asset's price movement.