Difference between Forwards & Futures

14/10/2020 1 By indiafreenotes

A forward contract is a customized contractual agreement where two private parties agree to trade a particular asset with each other at an agreed specific price and time in the future. Forward contracts are traded privately over-the-counter, not on an exchange.

A futures contract often referred to as futures is a standardized version of a forward contract that is publicly traded on a futures exchange. Like a forward contract, a futures contract includes an agreed upon price and time in the future to buy or sell an asset usually stocks, bonds, or commodities, like gold.

The main differentiating feature between futures and forward contracts that futures are publicly traded on an exchange while forwards are privately traded results in several operational differences between them. This comparison examines differences like counterparty risk, daily centralized clearing and mark-to-market, price transparency, and efficiency.

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 & 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)
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
Method of pre-termination Opposite contract with same or different counterparty. Counterparty risk remains while terminating with different counterparty. Opposite contract on the exchange.
Contract size Depending on the transaction and the requirements of the contracting parties. Standardized
Market Primary & Secondary Primary