amqata

The idea behind getting into a forward contract is to hedge a preexisting risk. Gemco expects to receive EUR 50 million, and it wants to lock in an exchange rate of USD 1.23/EUR by entering into a forward. At the expiration of the forward, Gemco is more or less guaranteed that it will receive USD 61.5m (50*1.23).

Bottom line: Gemco has effectively locked in a receipt of $61.5m, and the counterparty has locked in a payment of USD $61.5m.

Notice that it the parties had not entered the forward contract Gemco would be exposed to the risk that the dollar would appreciate (euro depreciate) and the counterparty would be exposed to the risk that the Euro would appreciate (dollar depreciate).

As it turns out, the market exchange rate at settlement is USD 1.25/EUR (EUR has appreciated).

Gemco would receive $62.5 m from the market for its 50m Euros. On the forward contract, since it had sold Euros, it loses $1 m. The net outcome for Gemco is a net inflow of $61.5 million.

The sentence in Schweser that begins with "The counterparty would...." is extremely confusing and rather redundant. What it means is that Gemco would have benefited by $1m if it HADN'T entered the forward, and the counterparty would have lost a further $1m if it HADN'T gotten into the contract.

In your post you ask "Why must a compensation be made to the party that was disadvantaged by the contract?" This is an incorrect statement. The compensation must be made to the party that would be disadvantaged had they NOT entered the forward contract.

On an UNHEDGED position Gemco would be able to exchange its Euros for US 62.5m, and the counterparty would have to pay out $62.5m.

Hope this clears it all up!