forward and future contract
- 1. Difference between forward contract and futures contract
- 2. Basis of difference Forward contract Futures contract definition A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time at a specified price. A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. Structure and purpose Customized to customer needs. Usually no initial payment required. Usually used for hedging Standardized. Initial margin payment required. Usually used for speculation. Transaction method Negotiated directly by the buyer and seller Quoted and traded on the Exchange Market regulation Not regulated Government regulated market (the Commodity Futures Trading Commission or CFTC is the governing body)
- 3. Basis of difference Forward contract Futures contract Institutional guarantee The contracting parties Clearing House risk High counterparty risk Low counterparty risk guarantees No guarantee of settlement until the date of maturity only the forward price, based on the spot price of the underlying asset is paid Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market rates with daily settlement of profits and losses. Contract maturity Forward contracts generally mature by delivering the commodity. Future contracts may not necessarily mature by delivery of commodity. Expiry date Depending on the transaction Standardized
- 4. Basis of difference Forward contract Futures contract Contract size Depending on the transaction and the requirements of the contracting parties. Standardized Market Primary & Secondary Primary
- 5. Advantages and disadvantages pf forward contract
- 6. Advantages of forward contract 1)No upfront fees. 2)No risk due to currency fluctuations completely eliminated. 3) Forwards are over-the-counter products. 4) It offers a complete hedge. 5) The use of forwards provide price protection. 6) They are easy to understand.
- 7. Disadvantages of forward contract 1) It requires tying up capital. There are no intermediate cash flows before settlement. 2) It is subject to default risk. 3) Contracts may be difficult to cancel. 4) There may be difficult to find a counter-party.