Forward and Future Contracts Difference

forward and future contracts difference

Forward contract is an agreement between two parties under which one party agrees to buy from the other party a specified amount of an asset on a specified date at a specified price.The investor agreeing to sell the product holds as short forward contract and the buyers holds a long forward position.

A future contract is a standardized tradable contract between two parties to trade a specified asset on a specified date at a specified time.All the details are pre-determined.

There is a thin line of difference between the two,the following example will explain the difference between the two. You wanted to buy a cow for your farm. You can either buy a cow of any color and breed or u may wish to buy a cow of a particular size and breed. Futures are like buying cows of any color or breed. They are standardized. Forwards are like buying a cow of a particular breed with no standardization.

The main differences between them are;

  1. Forwards are typically traded over the counter whereas futures are cleared through clearing houses.
  2. Forwards are generally private agreements therefore there is high risk of default on the side of parties whereas, in futures clearing house is involved so there is a dergree of guarantee of agreement involved.
  3. Forwards are settled at the end of the agreement on the specified date whereas futures are marketed on daily market basis,i.e, daily changes are settled day by day until the end of the contract.
  4. Forwards are usually used by hedgers who wants to eliminate the volatility of the price and delivery agreements of the asset. On the other hand,forwards are usd bt speculators who bets on the direction in which the price of the asset will move.
  5. Forwards are generally customized to consumer’s needs and involve no payments made in advance. On the other hand futures are standardized and involve payment of initial margins to avoid speculations in the contract.