Limitations of Forward Contract

The limitations/disadvantages of forward contracts are as follows:

  1. The user may not be able to negotiate good terms; the price may depend upon the size of the deal and how the user is rated.
  2. Users have to bear the spread of the contract between the buying and selling price.
  3. Deals can only be reversed by going back to the original party and offsetting the original trade.
  4. The creditworthiness of the other party may be a problem.
  5. Forward contract cannot be canceled without the agreement of both the counterparties.
  6. Forward contract requires tying up capital. There are no intermediate cash flows before settlement.
  7. Forward contracts are subject to default risk. There are cases in which suppliers intentionally breach the contract if they will incur a significant loss for implementing the contracts.

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