• These are agreements where 1 party agrees to buy a commodity at a specific price on a specific future date and the other party agrees to sell the product.
• Goods are actually delivered under forward contracts.
• Forward contract is a tailor made futures contract that is not traded on a organized exchange.
• Unless both parties are morally and financially strong, there is a danger that 1 party will default on the contract, especially if the price of the commodity changes markedly after the agreement is reached.
• It is an order that is placed in advance to buy or sell an asset or commodity.
• The price is fixed but you don’t pay for the asset until delivery date.
• Future markets have existed for long time for commodities like wheat, soyabin and copper.
• Major development of the 1970s occurred when the future exchanges began to trade contracts on financial assets like bond, currencies etc.
• A futures contract is a standardized product bought and sold in organized exchanges.
Forward Contract Vs Futures Contract
A futures contract is similar to the forward contract but with 3 key differences.
- Future contracts are “marked to market” on a daily basis, meaning that gains and losses are noted and money must be put up to cover losses. This greatly reduces the risk of default that exist with forward market.
- With futures, physical delivery of the underlying asset is virtually never taken- the 2 parties simply settle up with cash for the difference between the contracted price and the actual price on the expiration date.
- Futures contracts are generally standardized instruments that are traded on exchanges, whereas forward contracts are generally between 2 parties, and are not traded after they had been signed.