Difference between Forward Contract and Futures Contract

Forward Contract

•      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.

Futures Contract

•          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.

1. 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.
2. 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.
3. 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.