Forward contract
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Forward contract
/ˈfɔːwəd ˈkɒntrækt/ (also “forward sale”, “forward purchase” or just “forward” (n.)
A over-the counter transaction under which one fellow agrees now to sell an asset to another at a pre-agreed price at some time in the future. It is different from a future, which is a standardised, exchange-traded contract for the delivery of a certain asset at a pre-set date in the future.
Forwards have two main applications:
Hedging
As a way of locking in today a price for an asset you will only need in the future. It is a way of buying an asset without hacing to funds full purchase price before the point where you actually need the asset. You settle the payment and delivery at the time the contract matures.
Financing
Often used in financing arrangements such as repurchase agreements, which comprise simultaneously executed spot sale and forward purchase — so I transfer title to this thing, against agreeing to take it back from you at an agreed price at a stated time in the future. In this case the “lender” avoids taking exposure to the market value of the asset, but is able to have and hold it as collateral — together with margin — against the “borrower”’s ultimate repayment obligation.
“Forwards” versus “futures”
Forward contracts are private, bilateral, over-the-counter contracts that may be customised to the parties’ hearts’ content. They can thus be contrasted with futures contracts, which are exchange-traded, centrally cleared, standardised contract referencing the forward price of a commoditised asset, where there is no opportunity for customisation.
Popular types of forward contract
- Forward Transaction under the 2002 ISDA Equity Derivatives Definitions
- Forward Transaction under the ISDA Emissions Annex
See also
- Why Then I woke up and it was all a dream is not a great way of resolving settlement disruptions in a forward contract