Difference Between Forward and Futures Contract | Espresso

Difference Between Forward and Futures Contract

Forward contract and futures contract are two financial contracts that may seem pretty similar to one another. However, being a novice in trading, you need to know that there are quite a lot of differences between the two.

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They are similar in nature and usually follow the same essential function. However, the difference between forwards and futures contracts is quite striking.

Before going into the details of the differences between both the contracts, you should know that the major difference that these two have is that forwards are traded privately, whereas futures are traded on exchanges publicly.

What are Future Contract and Forward Contract?

Futures Contract

Futures contracts are also known as Futures which are traded through brokers or brokerage firms on the exchanges as standardised trading instruments. The terms for a futures contract are standardised for every contract like the delivery dates, volume, technical specifications, and credit procedures. Both the parties that are involved in Futures trading will work along with their respective brokers to transact in the trade.

Currency futures are generally the most traded futures contract on the exchanges. These are also called FX futures and here, the traders can exchange a currency with another on a particular date in the future at the current price, which is fixed on the purchase day.

Forward Contract

Forwards or forward contracts are the agreement that happens between two trading parties for either buying or selling an asset at a predetermined time, at a specific rate. This contract entails the market risk as well as the credit risk. Also, the profit or loss on Forward contracts is only known at the time of the settlement.

Similar to futures, Currency Forwards are a necessary contract in the foreign exchange market. This contract locks the currency exchange rate for any future sale for selling or buying a currency. It doesn’t involve any initial payment and is usually implemented in hedging. In Forwards Contract, the Currency Risk is lower than that of the Futures Contract.

Major Differences Between Future Contract and Forward Contract

In order to understand the differences between the two better, follow this simple chart –

 

Futures Contract

Forward Contract

Definition

Here, both the parties agree to buy or sell a particular asset at a fixed price and a predetermined date.

It is an agreement between both parties to purchase or sell an underlying asset at a specified date and a predefined rate in the future.

Traded On

A Futures Contract is traded on stock exchanges

Forward Contracts are traded Over the Counter (OTC).

Type

Futures Contract is standardised by the stock exchange according to its quantity, delivery date, etc.

Forward Contract, the terms can be negotiated between the parties, and hence, it is customizable

Size of Contract

Fixed

Depending on the contract terms.

Risk

Futures Contracts are less risky for traders. In futures contracts, an initial margin is compulsory.

Forward Contracts are risky. Also, in forward contracts, there isn’t any requirement of collateral.

Settlement

On a daily basis

On maturity date

Maturity

Predefined date

As per the terms of the contract

Regulation

 

As per the stock exchange

Self-regulated

Liquidity

 

High

Low

 

Conclusion

So, now that you are aware of the differences between the two, you should also know that for trading, you should also have a reliable stockbroker by your side. It is essential that you understand the market properly so that you can invest in a better manner to earn profits.

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Frequently Asked Questions

A forward contract is a tailor-made contract between two parties who wish to buy or sell an underlying asset at a specified value on a predetermined date in the future.

A futures contract has a high liquidity value. Whereas, forward contracts have low liquidity value.

Futures contracts are traded publicly on exchanges, unlike forward contracts. The latter is negotiated privately between the parties. Because futures contracts are regulated by the exchanges, they are less risky than forward contracts. Futures contracts are also standardised and come with set terms and expiry dates. On the other hand, Forward Contracts are tailored to the needs of the parties involved.

A futures contract is a standardised agreement by the stock exchange to buy or sell an underlying asset or commodity at a predefined price at a future date.