Derivatives trading involves a contract between parties to buy and sell assets at a given price and at a specific time. Companies and investors mainly use derivative contracts to hedge against risks or speculation. Futures and forwards are an example of derivative contracts whose value is derived from the underlying assets. These contracts are the same and follow similar fundamentals. However, there are certain differences between future and forward contact.
Meaning of Future Contract
A futures contract is a standardised financial contract under which the quantity and price are predetermined and payable at a future date. They are also called futures which can be traded in any segment, like stocks, commodities, currencies, etc., on a stock exchange. Furthermore, the parties are legally bound to execute the contract. The standardised terms and conditions of the futures contract include the following –
- Trade volume
- Delivery date
- Credit procedure
- Other technical specifications.
Meaning of Forward Contract
A forward contract is an agreement between two parties to buy or sell the underlying asset (stocks, commodities, etc.) at a specific price and at a specific time. Under this contract, you will know the profit or loss accrued at the time of settlement of the contract. Also, these contracts are not traded on a centralised exchange but are considered over-the-counter instruments.
Future Contract vs Forward Contract
The following are the differences between future and forward contract –
|Parameter||Future Contract||Forward Contract|
|Trading on Stock Exchange||Traded||Not traded|
|Type of Contract||Standard contract||Customizable depending on buyer and seller needs|
|Initial Margin||Required||Not required|
|Maturity Date||Standardized||Depending on the transaction|
|Contract Size||Standardized||Depends on the terms of the contract|
|Pricing||Standardized and transparent||Opaque pricing as two parties dictate|
|Trading||On Stock exchange||Over the counter|
|Settlement||Settled anytime during trading hours.||Settled at a specific maturity date|
|Type of Settlement||Cash settlement||Delivery of asset or cash settlement|
|Regulation||Regulated by stock exchanges||Self-regulated|
|Clearing House||Involved in settlement of futures||Not involved|
|Risk||Low counterparty risk||High counterparty risk|
Similarities Between Future and Forward Contract
The following are a few similarities between future and forward contract
- Both contracts are the type of derivative contracts
- It involves an agreement to buy or sell derivatives in the future.
- These contracts help to mitigate risk and losses due to price fluctuations.
- Both contracts use assumption techniques to lock in the price.
- Lastly, both these contracts require the buyer and seller to execute the transaction on a specific date.