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Difference between Forward and Future Contract
Forward and future contracts are used to reduce the risk of financial assets or speculation by investors or businesses.
What is a Forward Contract?
The contract is customized between two parties for an asset to be sold or bought on a future date at a specified date. Forward contracts are considered over-the-counter instruments. They do not trade on a centralized exchange and can be specially made to a specific commodity, amount, and delivery date. To avoid price instability, forward contracts can hold a particular price.
What is a Future Contract?
It is a standardized legal contract where something can be sold or bought at a specific price for delivery in the future at a given time. The parties would remain unknown to each other. The future contracts are financial by-products that compel the client to buy some eligible asset at an inevitable future price and date. Speculation on the direction of a security, commodity, or financial instrument is allowed to an investor in a future contract.
Difference between Forward and Future Contracts
The future and forward contracts might seem similar on a few points, but they have their differences, meaning, and function in their ways.
Characteristics | Forward Contract | Future Contract |
|---|---|---|
Form | A forward contract is a tailor-made
contract. | A future contract is a standardized
contract. |
Settlement | Done on the maturity date. | Done on a daily basis |
Default | The chances of default are
comparatively higher than the futures
contract as the forward contract is a
private agreement. | There is no such probability in a future
contract. |
Risk | The risk is high. | The risk is low. |
Collateral | It is not required. | The initial margin is required. |
Size of the
contract | The size depends on the contract
terms. | The size of the contract is fixed. |
Trades | It is done over the counter, and there is
no secondary market. | Traded on the organized stock exchange. |
Liquidity | It is low. | It is high. |
Regulation | It is self-regulated. | Regulated by the stock exchange. |
Maturity | As per the terms in the contract. | On the Prescribed date. |
Advantages and Disadvantages of Forward and Future Contracts
Just like the differences, they have their advantages and disadvantages.
Future contracts are regulated and traded on exchanges. This is why they are made public. They come with less risk of respondents. These contracts come with an expiry date and a set term.
But it’s different for forwarding contracts. Forward contracts are dealt with privately between the partners and have high-risk levels. The future contracts are personalized and need their parties to be involved. Usually, the agreements are done in private with the parties involved because they are traded over the counter. These products are not generally regulated and come with higher risks. The settlement isn’t made sure until the contract’s maturity date.
Conclusion
Now that you know the difference between forward and future contracts, you can start investing and your investment journey with a clear idea of how the contracts work. Before starting, you must have the proper knowledge and understand that you need to find a trustworthy financial partner. They can help you with the process and make sure you make the correct decisions. A well-known broking firm can be an advantage for you, such as creating Demat accounts and trading accounts.
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