Finance Contracts: Everything You Need to Know
Finance contracts are contracts that are used in accordance with securities law to allow for individually negotiated agreements.3 min read
2. Options Contracts
3. Forward Contracts
4. Forward Contracts or Futures Contracts
5. How Contract Finance Works
Finance contracts, or financial services contracts, are contracts that are used in accordance with securities law to allow for individually negotiated agreements involving commodities, securities, currencies, or other interests of an economic or financial nature. These contracts are used for buying, selling, lending, swapping, and repurchasing within the financial markets. Different kinds of financial deals will require different variations of the basic finance contract.
Options contracts are a kind of finance contract that involve a seller and buyer agreeing to give the option’s purchaser the right to sell or buy an asset at an agreed upon price at a specified date. Such contracts are common to commodities, real estate, and securities transactions.
Forward contracts are a kind of finance contract that involve private agreements between two parties that give the buyer the obligation to buy an asset at an agreed upon price at an agreed upon time. Assets involved in these contracts include such commodities as precious metals, grains, oil, electricity, natural gas, and livestock, for example, although financial instruments and foreign currencies are now common also.
Forward Contracts or Futures Contracts
Forward contracts are very similar to futures contracts insofar as they both let one sell or buy assets at specific times for specific prices, but futures contracts are standardized and traded on an exchange, unlike forward contracts. Additionally, futures contracts settle on a daily basis, which means both parties involved must be able to handle the price fluctuations over the contract’s life, unlike the case with forward contracts, where settlement happens at the end of the contract only.
That said, parties partaking in forward contracts generally bear greater risk to their credit than those that deal in futures contracts due to the fact that there is no clearinghouse guaranteeing performance. Because of this, the risk that a party in a forward contract will be forced to default is always present, and the party harmed by this may have no recourse other than to sue. Thus prices for forward contracts often come with premiums because of the additional credit risk.
How Contract Finance Works
When it comes to finance contracts, most lenders desire some way to control or monitor their payments and expenses. The method used by them is determine by the other party’s professional reputation as it pertains to their trading history and delivery reliability. The more a business is established, the less a lender will feel the need to be in control of the related finances. The financing options are as follows:
- Purchase order finance. This form of finance is a short-term advance or loan that is secured by contract or purchase order to pay for the raw materials, inputs, packaging, trade or finished goods for resale, or other items needed to provide a service or make and ship a product. Some lenders may also offer financing for purchase orders that may be used to finish the contracted work.
- Lender-controlled money. In this form of finance a separate bank account is created to hold the loan amount for the contract. The entity that awarded the contract will place payments into the new account in accordance with the terms of the contract. To receive the most from such a financing arrangement, a close relationship to the lender and good communication is beneficial. When the contract is finished and the final payment is made, the lender will deduct any fees, deposit any remaining money in your business account, and then close the lending account.
- Borrower-controlled money. In this form of finance, you have control of the contract and finances. The money in question will be available in the form of an overdraft or short-term loan for the contract’s duration and the bank involved will monitor the account transactions so as to ensure that the finances are being managed responsibly. Interest charges are deducted from this account each month, and by the end of the contract the full cost of the loan will have to be repaid. If the contract allows it and the lender feels the situation demands it, they will be able to step in and take control of the money. Such a detail should be noted before a contract is signed.
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