Legal Definitions - financial contract

A financial contract is a legally enforceable agreement between two or more parties that involves financial assets, liabilities, or risks. It sets out the terms and conditions for the exchange, transfer, or management of money, securities, or other financial instruments, often involving commitments for future payments or performance. Like any contract, it creates specific rights and obligations for each party involved, which can be enforced by law.

• Example 1: Mortgage Agreement

  When a person buys a house and takes out a loan from a bank, they enter into a mortgage agreement. This agreement is a financial contract where the bank lends a specific sum of money, and the homeowner promises to repay that money, plus interest, over a set period. The house itself often serves as collateral. This is a financial contract because it involves the transfer of a large sum of money, creates a financial liability (the loan) for the homeowner, and establishes a long-term financial obligation with specific terms for repayment and potential consequences for default.

• Example 2: Investment Management Agreement

  An individual who hires a financial advisor to manage their investment portfolio typically signs an investment management agreement. This contract outlines the scope of the advisor's authority, the types of investments they can make on behalf of the client, the fees the client will pay, and the client's financial goals and risk tolerance. This constitutes a financial contract because it governs the management of financial assets (the investment portfolio), specifies financial services, and details the financial compensation (fees) for those services, creating mutual financial obligations and expectations.

• Example 3: Futures Contract for Commodities

  A farmer might enter into a futures contract to sell a certain quantity of their corn harvest at a predetermined price on a future date. This agreement is a financial contract between the farmer and a buyer (or a financial institution acting as an intermediary). It specifies the commodity, quantity, price, and delivery date. This is a financial contract because it locks in a future financial transaction for a tangible asset (corn), manages price risk for both parties, and creates a legally binding obligation to exchange the commodity for money at a future point, regardless of market price fluctuations at that time.