What is Advance Commitment

An advance commitment is a promise or agreement to take some future action. In finance, it is often related to the buying or selling of an asset at some future time, often with pre-agreed terms.

Futures contracts are a type of advance commitment, except that the buyer or seller of the contract can back out of the contract by taking an offsetting position as long as it is before the expiry date.

Breaking Down Advance Commitment

Advance commitments occur in the financial markets, business, and other areas of life.

In the financial markets, parties may make an advance commitment to buy or sell an asset. This is commonly done with a futures contract. The person buying the contract is agreeing to buy the underlying asset at the agreed price when the contract expires. The seller of the contract is agreeing to provide the underlying asset to the buyer, and in exchange receives the funds from the buyer. Exchange-traded futures contract can be offset prior to expiry. The the buyer and/or seller receives their gain or loss on the contract, but removes their obligation to buy or deliver the underlying asset.

Short selling a stock is also a form of advance commitment. When a trader sells a stock they don't yet own, hoping to buy it back at a lower price, they are creating an obligation to buy back the shares they short sold at a future date. Although, in this case, the price they will buy the shares at, and when, is unknown at the time of the initial short sale.

In banking, a financial institution will make an advance commitment to a borrower to lend funds on a specified date with agreed-upon terms. This is often the case with a mortgage, as the day the loan is granted is different than the day when the funds are sent to the home seller on behalf of the buyer. A home buyer may go through the process of getting the loan approved before they fully commit buying a house. In doing so, they know the bank has made a commitment to fund the purchase even if they don't take possession of the house for several weeks or even months. In mortgage banking, an advance commitment is called a "standby commitment."

In everyday life, getting engaged to be married is an advance commitment, with action of getting married to come at a later date. Offering to borrow a friend money next Friday is also a form of advance commitment.