Forward Contract

Trading

Quick Definition

A Forward Contract is a customized agreement between two parties to buy or sell an asset at a fixed price on a future date.

Detailed Explanation

A Forward Contract is a type of derivative traded privately (over-the-counter, OTC), not on exchanges. It allows parties to lock in a price today for a transaction that will occur in the future.

These contracts are widely used in forex, commodities, and business transactions to manage price risk.

Key Features of Forward Contracts

  • Customized terms (price, quantity, date)
  • Traded OTC (not on exchange)
  • Settlement at a future date
  • No daily margin requirement (unlike futures)

Forward Contract vs Futures Contract

  • Forward Contract: Private, customizable, higher counterparty risk
  • Futures Contract: Standardized, exchange-traded, lower risk

Why Forward Contracts Matter

  • Helps hedge against price fluctuations
  • Provides certainty in future transactions
  • Useful for exporters, importers, and businesses

Risks & Considerations

  • Counterparty risk (default by one party)
  • Lack of liquidity
  • No standard regulation like exchange-traded products

Example

"An exporter agrees today to sell $10,000 at ₹85 per dollar after 3 months—this is a forward contract."

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