What is 'Forward Delivery'

Forward delivery is the final stage in a forward contract when one party supplies the underlying asset and the other pays for and takes possession of the asset. The alternative is for a cash settlement at the expiration of the forward contract. Delivery, price and all other terms must be written into the original forward contact at its inception.

BREAKING DOWN 'Forward Delivery'

A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract is used for hedging and for speculation, although its non-standardized nature makes it particularly apt for hedging. Unlike standard futures contracts, a forward contract can be customized to any commodity, amount and delivery date. A forward contract settlement can occur on a cash or delivery basis.

When the contract settles in actual delivery of the underlying asset, that final stage is called forward delivery. Otherwise, the contract settles for cash.

The market for forward contracts is very large, since many of the world’s biggest corporations use it to hedge currency and interest rate risks. However, since these contracts are private transactions between counterparties, the general public does not have access to the details. That makes the size of this market difficult to estimate.

The main problem with the forward contract market is counterparty risk. One party or the other may not execute their half of the transaction and that could lead to losses for the other. In the worst-case scenario, the market may be susceptible to a cascading series of defaults.

Forward Contracts vs. Futures Contracts

Because futures contracts are standardized and trade on exchanges, counterparty risk is mitigated by the exchange's clearing mechanism. Further, there is a ready trading market should either the buyer or the seller decide to close out their position ahead of expiration.

Tighter regulation of futures ensures a fair market, and daily mark to market protects traders from running up huge, unrealized losses. Margin requirements prevent this.

Forward contracts trade over the counter with many fewer safeguards.

Another important difference is the upfront cost. The buyer of a futures contract must pay the current price and hopes the price will rise before expiration. The buyer of a forward contract does not pay up front but locks in the price he or she will pay later. Both contract profit from the difference between current and future prices, however.

Because of the increased counterparty risk, the seller of the forward contract could be stuck with a large amount of the underlying asset should the buyer fail to meet his or her obligations.

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