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What is the difference between forward contract and futures contract?
In forward contract, terms are negotiated between parties. In this, parties trade underlying asset a certain or agreed price at particular future time. This contract differs from future contract (standardized form of forward contract) whereas in future contract parties buy or sell underlying financial asset at particular rate in future time. Future contracts are traded in exchanges and forward contract are in over the counter (OTC).
By seeing their overview both contracts look same but when you go deep or dig further then you can see in what aspects they will differ and their grounds. Before digging deep into contracts let us see an overview of contracts separately
In this settlement date, quantity, quality and rates are fixed. These traded in decentralized markets (in this markets terms can be customized as per parties concerned). In this contracts buyer holds LONG POSITION and seller holds SHORT POSITION. At the time of transaction if asset price rises above agreed price then buyer makes profit. Similarly, at the time of transaction if asset price falls below agreed price then seller makes profit
In this quantity, date and delivery are standardized. In this buyer holds LONG POSITION and seller holds SHORT POSITION. In this market price subjected to fluctuations due to this reason price difference is settled daily. Again these are categorized into commodity futures (commodities) and financial futures (financial instruments).
The major differences between a forward contract and a future contract are as follows −
|Forward contract||Future contract|
|It is an agreement between buyer and seller underlying asset on particular date (future) at an agreed rate.||It is an agreement between buyer and seller to exchange asset for cash on specified date (future) at fixed price.|
|It includes negotiations.||It is a standardised contract.|
|Traded over countries.||Traded on organised stock exchange.|
|Settlement on maturity date.||Settlement on daily basis.|
|High risk.||Low risk.|
|Chances of default is high (because it is a private agreement).||No probability of default.|
|Depending on terms size of contract is determined.||Contract size is fixed|
|Maturity depends on terms and conditions.||Maturity depends on predetermined date.|
|Self-regulated.||Regulated by stock exchange.|
|Low liquidity.||High liquidity.|
|No initial margin is required for collateral.||Initial margin is required for collateral.|
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