A:

Fundamentally, forward and futures contracts have the same function: both types of contracts allow people to buy or sell a specific type of asset at a specific time at a given price.

However, it is in the specific details that these contracts differ. First of all, futures contracts are exchange-traded and, therefore, are standardized contracts. Forward contracts, on the other hand, are private agreements between two parties and are not as rigid in their stated terms and conditions. Because forward contracts are private agreements, there is always a chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never.

Secondly, the specific details concerning settlement and delivery are quite distinct. For forward contracts, settlement of the contract occurs at the end of the contract. Futures contracts are marked-to-market daily, which means that daily changes are settled day by day until the end of the contract. Furthermore, settlement for futures contracts can occur over a range of dates. Forward contracts, on the other hand, only possess one settlement date.

Lastly, because futures contracts are quite frequently employed by speculators, who bet on the direction in which an asset's price will move, they are usually closed out prior to maturity and delivery usually never happens. On the other hand, forward contracts are mostly used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place.

For further reading, see Futures Fundamentals.

RELATED FAQS

  1. How do futures contracts roll over?

    Learn about why futures contracts are often rolled over into forward month contracts prior to expiration, and understand ...
  2. How does a forward contract differ from a call option?

    Find out more about forward contracts, call options, the mechanics of these financial instruments and the difference between ...
  3. Why do companies enter into futures contracts?

    Learn how companies use futures contracts for the purposes of hedging their exposure to price fluctuations as well as for ...
  4. What does a futures contract cost?

    Learn about values of futures contracts and the initial margin a trader must place in an account to open a futures position, ...
RELATED TERMS
  1. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  2. Best To Deliver

    The security that is delivered by the short position holder in ...
  3. Exchange Traded Derivative

    A financial instrument whose value is based on the value of another ...
  4. Cash-And-Carry Trade

    A trading strategy in which an investor buys a long position ...
  5. ISDA Master Agreement

    A standard agreement used in over-the-counter derivatives transactions.
  6. Fixed Income Forward

    A contract to buy or sell a fixed income security in the future ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB US Dollar

  2. Options & Futures

    How does a forward contract differ from ...

  3. Stock Analysis

    Southwest & Cheap Oil: The Perfect Combination?

  4. Options & Futures

    Tax Treatment For Call & Put Options

  5. Mutual Funds & ETFs

    The Top 3 Silver ETFs

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!