PF Primer

Futures contract versus forward contract

A futures contract is an agreement between two parties to buy or sell a specified and standardised quantity and quality of an asset or a security on a certain date at a certain price agreed at the time of entering into the contract on the futures exchanges.

A forward contract is an agreement entered between two parties to buy or sell an asset at a future date for an agreed price while entering into a forward agreement. The terms and conditions of forward contracts are customised based on negotiations between the counter parties . A forward contract is not traded on an exchange.

Contract’s Size:

A futures contract is highly standardised in terms of the quantity and quality of an asset as specified by the exchange. The size of the forward contract is customised as per the negotiated terms of agreement between a buyer and seller.

Price Transparency:

The contract price of a futures contract is trans-parent given the availability of a trading screen that provides both bidding and asking prices at any given time. The contract prices of forward agreements are not transparent given the bilateral nature of the agreement and non-disclosure of prices in public domain.

Open Position Valuations & Margin Requirement:

For futures , valuation of mark-tomarket (MTM) position is calculated as per the official closing price on a daily basis and MTM margin requirement exists , where the party in profit will receive money and the other way round. In case of a forward contract, valuation of open position is not calculated on a daily basis and there is no requirement of MTM.

Liquidity:

Generally, futures contract is more liquid as it is traded on the exchange. Forward contract is less liquid due to the customised nature and nonavailability of an exchange-like trading platform.

Counter-Party Risk:

In futures contract, exchange guarantees a trade by making clearing house a party to each and every trade. In other words, there is no counterparty risk. On the other hand, being a bilateral agreement between two parties, the counterparty risk is high in case of forward contracts.