You Might Also Like: A currency swap occurs when two parties exchange cash flows denominated in different currencies. The assets which are bought and sold can be either physical commodities or financial instruments. Therefore, they are also not traded on formal exchanges and are instead traded as an over the counter security. Also, futures differ from forwards in that they are standardized and the parties meet through an open public exchange, while futures are private agreements between two parties and their terms are therefore not public.
Key Differences Between Forward and Futures Contract
Please do not give this as a definition of a Futures Contract in an interview or exam — I would like you to frame it on your own because it would help!
Though they are very similar to Forwards, the definition alone is not the only difference. Margins come in two types:. This is an amount to be put up with the exchange as you enter into the contract. This is the minimum amount of money that has to remain in the margin account below which that particular counterparty again has to put up margin to the level of the initial margin.
In this case, a Margin Call is said to have been triggered. The above example should be more than enough to clarify your doubts regarding Futures Contracts. Nevertheless here are some points to note:. The example above is a very simplistic one but gives you an idea of how a margin account is maintained with the exchange.
In other words, since futures contracts try to remove counterparty risk as they are exchange traded , there are margin requirements in place. Next, there are multiple futures prices which are based on the different contracts. Take a look at the following picture:. If B decides to terminate the contract before expiration, then the Exchange is the counterparty as it prevents A from being orphaned. The is how trading futures benefits us since the exchange takes opposite positions to help us out.
How lucky are we! The Futures market created liquidity by standardizing the contracts through the underlying in three ways:. The quality of the underlying though by definition may be the same, are not exactly the same. These are mentioned in the terms of the contract.
You may have an underlying as potatoes for example. But the sand content may not be the same or the number of pores may not be the same when it is delivered. Thus the specifics may not exactly be the same. You may want to trade only 50 potatoes for delivery else short term trading in the futures market. But the exchange may allow you to only trade in lots of 10 where each lot consists of 10 potatoes.
Thus the minimum number of potatoes you can trade is potatoes and not 50 which is your requirement. This is another way standardization occurs. Maturity dates are available on the exchange. For example the last Thursday of each month is fixed as the maturity day. The immediate contract is called the near month contract front month contract ; the contract maturing next month is called the next month contract back month contract ; contracts post that are called far month contracts.
The underlying is then bought or sold a few days after maturity called as the settlement date. There is a lot of information given — no doubt almost everything you need to know about forwards vs futures are present except for numerical problems. Due to its liquidity, Futures are more commonly traded than Forwards in general although it depends on the underlying. This has been a guide to highlighting the key differences Forwards vs Futures. You may learn more about derivatives from the following articles —.
Very useful resource, I found lot of interesting things in your website. Futures, options and forward contracts belong to a group of financial securities known as derivatives. The profit or loss resulting from trading such securities is directly related to, or derived from, another asset, such as a stock.
There are, however, crucial differences between these three derivative securities, which you should understand before investing in them.
An option gives the holder the right -- but not the obligation -- to buy or sell an asset at a specific price on a specific date. A call option represents the right to buy, while a put option represents the right to sell. Forward contracts are binding agreements to buy or sell an asset at a specific price on a specific date. One party to such an agreement will have an obligation to buy, and the other will have an obligation to sell. Such contracts can involve practically anything of value, including stocks, bonds, foreign currencies, agricultural commodities such as corn or soybeans, and valuable metals, including gold and silver.
The asset that changes hands is referred to as the underlying asset, or simply "the underlying. A futures contract is simply a standardized forward agreement. If you are a cereal manufacturer and buy a lot of corn, it would be time-consuming to negotiate a different forward contract with every corn farmer.
To streamline the process, large commodities exchanges offer standardized agreements through which corn, for example, is traded in increments of 1, bushels on specific dates. The specifications of corn to be delivered are also set.
That way, the buyer and seller can select one of the standard contracts, changing only the quantity as suits their needs.