What is a 'Forward Commitment'

A forward commitment is a contractual agreement between a buyer and seller to carry out a transaction in the future. A forward commitment will specify the commodity or good being sold, the price, payment date and delivery date. Forward commitments are contained within several types of derivatives, including forward contracts, futures contracts and swaps.

BREAKING DOWN 'Forward Commitment'

Forward commitments are a mechanism for two parties to reduce the risks and uncertainties around a planned transaction in the future. For example, a producer of a commodity like wheat knows he must sell his crop at some point after harvest. A futures contract with a forward commitment allows the producer to find a buyer in advance, locking in the sale price for the producer and removing pricing variability for the buyer over that same time period. Forward commitments can, of course, be traded in the form of contracts. So the agreement between the producer and the end customer may end up being traded between parties who have no direct interest in actually taking delivery of the underlying.

Other Types of Forward Commitment

Forward commitments are closely associated with commodities due to the heavy use of futures in this market, but the term applies to a range of financial arrangements in which two parties agree to the terms of a future transaction well in advance of it occurring. Forward commitments can cover the future purchase of financial products or any other asset where two parties want to remove pricing volatility for a set period of time. Usually a forward commitment is reserved for products where there is a time lag between creation and sale, as with a commodity that is extracted or harvested.

Forward commitment is also used in the context of loans. Property builders may enter a forward commitment with a bank to lock in the interest rates and terms of a loan prior to it being required for the development. This formal arrangement provides the borrower with the security of knowing they will have the funds when needed. For the lender, a forward commitment gives them the ability to forecast future business more accurately.

Forward Commitment vs. Contingent Claims

Derivatives can contain forward commitments or contingent claims. A forward commitment contains an obligation to carry out the transaction as planned, whereas a contingent claim contains the right to carry out the transaction but not the obligation. As a result, the payoff profiles between these derivatives vary, and that impacts how the contracts themselves trade. The value of a derivative with a forward commitment will move more or less in lock step with the price of the underlying. In contrast, a contingent claim derivative will increase or decrease with the likelihood of the right being exercised for a profit.

  1. Forward Forward

    A forward forward is an agreement between two parties to engage ...
  2. Capital Commitment

    Capital commitment is future capital expenditures that a company ...
  3. Forward Delivery

    Forward delivery is the final stage in a forward contract when ...
  4. Buying Forward

    Buying forward is an investment strategy that involves the buying ...
  5. Outright Forward

    An outright forward is a forward currency contract that locks ...
  6. Commitment Fee

    A commitment fee is charged by a lender to a borrower for an ...
Related Articles
  1. Trading

    The Difference Between Forwards and Futures

    Both forward and futures contracts allow investors to buy or sell an asset at a specific time and price.
  2. Investing

    Contingency Clauses In Home Purchase Contracts

    Here, we introduce widely used contingency clauses in home purchase contracts and how they can benefit both Buyers and Sellers.
  3. Trading

    An Overview Of Futures, Derivatives, and Liquidity

    Gain an understanding of futures and derivatives, and how these instruments are meant to mitigate market risk.
  4. Trading

    Using interest rate parity to trade forex

    Learn the basics of forward exchange rates and hedging strategies to understand interest rate parity – fundamental knowledge for foreign-currency traders.
  5. Investing

    Housing deals that fall through

    Find why buyers back out, and what you can do if you're left holding the bag.
  6. Trading

    Advantages Of Trading Futures Over Stocks (APPL)

    We look at the top eight advantages of trading futures over stocks.
  1. What is a forward contract against an export?

    Understand forward exchange contracts in exporting, and learn the purpose of using a forward contract and its advantages ... Read Answer >>
  2. What is the Difference Between a Forward Rate and a Spot Rate?

    The forward rate is the settlement price of a forward contract, while the spot rate is the settlement price of a spot contract. Read Answer >>
  3. What is the difference between derivatives and options?

    A derivative is a financial contract that gets its value from an underlying asset. Options offer one type of common derivative. Read Answer >>
  4. How does a forward contract differ from a call option? (AAPL)

    Find out more about forward contracts, call options, the mechanics of these financial instruments and the difference between ... Read Answer >>
  5. How are futures used to hedge a position?

    Futures contracts are one of the most common derivatives used to hedge risk. Learn how futures contracts can be used to limit ... Read Answer >>
Trading Center