A forward contract openly traded on a futures exchange is a futures contract or simply “futures.” A futures contract, like a forward contract, specifies a price and a future date for the purchase or sale of an asset, typically stocks, bonds, or commodities like gold.
A forward contract is a special kind of contract when two private parties concur to exchange a particular asset at a fixed price and time in the future. Instead of an exchange, forward contracts are privately exchanged over the counter.
PRIMARY DIFFERENCE
There are numerous operational distinctions between futures and forward contracts due to the significant difference between them, being that futures are traded openly on an exchange while forwards are transacted privately. In this analysis, discrepancies are compared in terms of counterparty risk, daily centralized clearance and mark-to-market, price transparency, and efficiency.
DIFFERENTIATION IN DETAILS
| FORWARD | FUTURES | |
| DEFINITION | Forward contract is a raport with two parties to purchase or sell an asset (of any sort) at a determined price at a future date that has been agreed upon. | A futures contract is a standardized agreement exchanged on a futures exchange that allows parties to acquire or sell a certain underlying instrument at a fixed price and specific date in the future. |
| Structure & Purpose | Forward is tailored to the demands of the client. Usually, no upfront money is necessary. Usually employed as a hedge. | While Futures is standardized. Required: initial margin payment. Used a lot for speculating |
| Transaction Method | Forward does direct negotiations between the buyer and the seller. | Futures are traded and quoted on the Exchange. |
| Market Regulation | Forward is not regulated. | Futures are government-regulated market |
| Institutional Guarantee | The contracting parties | Clearing House |
| Risks | High Counterparty Risk | Low Counterparty Risk |
| Guarantees | Only the forward price, depending on the spot price of the underlying asset, is paid, and there is no guarantee of settlement until the day of maturity. | Both parties are required to put down a first guarantee (margin). The operation’s worth is pegged to market rates with daily gains and losses settled. |
| Contract Maturity | Typically, forward contracts are fulfilled by the delivery of the commodity. | The delivery of goods might not always fulfil future contracts. |
| Expiry Date | Depending on the transaction | Standardized |
| Method of Pre-Determination | With the same or a different counterparty, opposite contract while terminating with a foreign counterparty, there is still a danger in the counterparty. | Opposites contract on the Exchange. |
| Contract Size | Depending on the transaction and the needs of the parties to the contract. | Standardized |
| Market | Primary & Secondary | Primary |
OVERVIEW
Both future and forward contracts are written agreements between two or multiple parties to acquire or sell the underlying asset at an agreed price at a given date, which makes them comparable.
The ability to hedge risk is offered to market players by both futures and forwards (i.e., offset potential losses).
But the way futures trading is facilitated on exchanges and settled through a clearinghouse distinguishes futures from forwards (and thus are more standardized with more centralized oversight).