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This paper defines and explains the forward contracts as a financial tool and describes how it can be applied in the case of Ikea Company that is projecting to open a branch in New Zealand. Indeed, a retrospective graph is constructed to indicate the relevant currency pairs and to elaborate how financial contracts and promotions may be utilized by the company or stabilize prices and profits.
Use of forward contracts by the Ikea Company
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By definition, a forward contract refers to a business agreement made between two agents - the party and the counterparty - to carry out a buying or selling transaction for a specified quantity of a particular commodity at a stipulated price on a particular point in time in the future (Buchanan, 2008, p. 123). In essence, the forward is a transactional obligation that the partners enter into to buy or sell at the price, quantity and time agreed upon. In the case of Ikea Company, a forward contract would involve building business partnerships with selling corporations in New Zealand and developing a formal project with them to be selling the company's furniture in the country by importing them directly from the new production branch that will be opened there. In the event that the party or the counterparty breaches the contract, they are liable to legal and financial consequences, although the party or counterparty of the contract can effectively cancel the forward contract by entering into what is called an opposing forward contract (Buchanan, 2008, p. 124).
To illustrate the use of forward contracts in the proposed Ikea project, the figure below can be used to indicate the monthly values of the forward prices and the margin balance for the hypothetical 12-month forward contract. The first column should indicate the months of the contract, the second indicates the number of contracts, the third the forward prices, the fourth the changes in forward prices between the present and the previous month, and the last column indicates the margin balance which is the difference between the forward price in a particular month and the price during the previous month in order to help monitor the prices and determine the prices made every month from the sale of Ikea furniture by forward contracts.
The ultimate profit (or loss) that Ikea will make from the forward contract will be computed from the difference between the marginal balance at the end of the contract and forward value of the initial margin balance.
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Considering the Ikea venture into the New Zealand furniture market, forward contracts would be recommendable chiefly because it reduces the risk of the market prices moving against Ikea, the party in this case, as well a the counterparty in case other sellers offer similar furniture at lower prices (Buchanan, 2008, p. 129). Additionally, a forward contract is recommendable for the company because the payment to be made for the forward by the prospective buyers and the transfer of ownership of the furniture will occur simultaneously at a future agreed upon time after the determination of the price for the furniture when the contract is sealed. As such, the forward contract will buffer Ikea from losses due to possible reduction of furniture prices in the New Zealand market even if this happens before the ownership of the agreed upon quantity of furniture is transferred to the buyers.