Difference Between Forward and Future Contract

Difference Between Forward and Future Contract

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Anshuman
Anshuman Singh
Senior Executive - Content
Updated on Feb 21, 2024 15:19 IST

The main difference between forward and future contract is that a forward contract is privately traded; on the other hand, a future contract is publicly traded on an exchange.

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In this article, we will go through the difference between forward and future contract in great detail. But, before that, let us go through the topics listed under the table of contents (TOC) that we will cover in this article.

Table of contents (TOC)

You can also explore: Difference Between Void and Voidable Contract

Difference between forward and future contract 

For better understanding, let’s explore the difference between forward and future contract in a tabular format:

Parameter Forward contract Future contract
Contract type Tailor made contract Standardized contract
Traded on Over the counter Organized stock exchange
Settlement happens On the maturity date Daily
Risk High Low
The size of the contract is fixed No. It depends on the contract terms Yes
The maturity date is Based on the terms of the private contract Predetermined
Zero requirements for initial margin Yes No
The expiry date of the contract Depends on the contract Standardized
Liquidity Low High

What is a forward contract?

Forward contract definition: A forward contract is a type of agreement among two parties to purchase or sell an asset (of any kind) at a specified price at a pre-determined future time.

A forward contract has more flexible contract terms, such as the number of units to be sold, what will be delivered and when, and various other factors. To understand this better, let’s go through an example.

Forward contract example: Aman wants to sell grain at the current rate of Rs.26, but he feels that the grain prices might fall in the coming months due to certain conditions. So, he decides to sign a forward contract with a grocery shop. According to the contract, Aman will sell grains after three months at Rs 26. If the price of grain falls to Rs.26, Aman will not incur any loss. However, if grain prices rise, Aman will only receive the price stated in the contract.

What is a future contract?

Future contract definition:A futures contract is a legal binding that is traded on a futures exchange to buy or sell a specific underlying component at a specified price at a future date.

It includes an intermediary (clearance house, a division of a stock exchange) between two parties. Because each party collaborates with the clearing house that monitors the transaction, the default risk that may seem too troublesome in a contract is drastically decreased in a future contract. To understand this better, let’s go through an example.

Example: Aman and Rashmi are two individual parties. Aman is an iron producer, and Rashmi owns a business that frequently requires iron. Rashmi agrees to trade a certain amount of iron (say, 90 kg), and both parties agree to a fixed price (say, 400/kg) for trading the iron on a future date. The future contract will be executed at the agreed-upon price at the delivery time, irrespective of the market price at the expiration date. 

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Key difference Between Forward and Future contract

Here are the key differences between forward and future contract:

  • A forward contract is not formally regulated, whereas a futures contract is subject to stock exchange regulation.
  • A forward contract usually has only one specified delivery date, whereas a futures contract has a range of delivery dates.
  • The forward contract is a custom-made or tailor-made contract, whereas a future contract is standardized in quantity, quality, and delivery date.
  • A forward contract is signed face-to-face (or over the counter) between two parties, whereas a futures contract is signed between two parties via an intermediary.

Conclusion

A forward contract is completely customizable because both parties can set the price, date, and contract terms at their leisure. As a forward contract is signed between two private parties linked by a broker-dealer and not executed via an exchange, the counterparty risks are quite high. This is why traders and investors frequently use forward contracts to safeguard their positions. Now that you recognize the difference between forward and future contract, you can embark on your financial journey with certainty and assurance.

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FAQs

What is the main difference between forward and future contract?

The main difference between forward and future contract is that a forward contract is privately traded; on the other hand, a future contract is publicly traded on an exchange.

In terms of the difference between forward and future contract, which one of the two is traded on an organized trade exchange?

Regarding the difference between forward and future contract, the future contract is traded on an organized trade exchange.

In terms of the difference between forward and future contract, which one of the two has high risk and why?

Regarding the difference between forward and future contract, a forward contract has high risk as it is signed between two private parties linked by a broker-dealer and not executed via an exchange; the counterparty risks are quite high.

In terms of the difference between forward and future contract, which one of the two has low liquidity?

Regarding the difference between forward and future contract, a forward contract has low liquidity.

In terms of the difference between forward and future contract, which one of the two has no requirement for an initial margin?

Regarding the difference between forward and future contract, a forward contract has no requirement for an initial margin.

About the Author
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Anshuman Singh
Senior Executive - Content

Anshuman Singh is an accomplished content writer with over three years of experience specializing in cybersecurity, cloud computing, networking, and software testing. Known for his clear, concise, and informative wr... Read Full Bio

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