Forward contracts versus Future contracts
Commodity brokers use forward and futures contracts for which reason? Points of difference between forward contracts and financial futures are as under:
- Forward contracts are available in any amount, small or large, whereas financial future contracts are in standard size.
- Forward contracts are meant for bonafide trade transactions whereas in futures anyone can participate whether for bonafide trade purposes, non-trade or speculative purpose.
- In the inter-bank market, forward exchange contracts are tailored to meet specific requirements of the customer as to amount and maturity date whereas futures contracts are standardized as to amounts.
- Trading is done by telephone or telex in the inter-bank forward exchange markets and at any given moment, buy and sell quotations by different dealers may very slightly from another whereas in the futures market, trading is by “open outcry” of bids, offers and amounts in a single arena.
- Finding the most favorable price in the inter-bank market is a cumbersome calculation compared to futures market where bids and offers are continuously revealed in a central place.
- In inter-bank forward exchange market trading is done on a principal-to-principal basis, hence participants always know the counter-party to the contract, whereas in the financial futures market participants deals through exchange members authorized to do business on the floor.
- In the forward market there is some counter-party risk but not in the futures market where exchange clearing house guarantees performed of the contract.
- In forward exchange market deposit of margin for each transactions is not a must whereas in financial futures market all participants must post initial cash margins, and keep it covering up to meet shortfall if any as indicated by the daily mark to market calculation.
- In forward market gains and losses on position values accrue on settlement dates whereas in the financial futures market gains and losses on position values are settled daily.
- Banks dealing in forward exchange obtain their profit from the difference between the buying and selling rates (the spread) whereas future market brokers charge their customers a fixed rate of commission for each contract they buy or sell.
- No limit exists on the range of price fluctuations in the forward exchange market, whereas in the case of futures contracts such limits and prices may not appreciate or depreciate by more than a set amount from the previous day’s closing price.
- On the forward exchange market nearly all contracts are completed by delivery and acceptance of currencies by the parties involved whereas future contracts are nearly always settled by a liquidating sale or purchase prior to delivery