Forward contract
What is Forward contract?
A forward contract is a bilateral agreement to buy, sell, or cash-settle a specified underlying amount at a future date and price under negotiated terms.
Because forwards are customized, two contracts with the same notional and maturity can differ through settlement, collateral, netting, credit support, calendars, and termination rights. Operational records must preserve the signed confirmation and amendments. Portfolio systems should separate economic hedge performance from counterparty valuation adjustments and identify gross settlement amounts that can be much larger than net market value.
How forwards differ from futures
Forwards are typically over the counter and customizable in amount, date, underlying, settlement, collateral, and legal terms. Futures are standardized, exchange-traded, centrally cleared, and commonly marked daily. Some forwards are collateralized or cleared, so the distinction depends on actual structure. Customization can improve hedge fit while reducing transferability and price transparency.
Example
An exporter will receive EUR 1 million in three months and sells euros forward against its base currency. The contract fixes a conversion rate and reduces exchange uncertainty. If the euro later strengthens, the forward loses relative to spot while the receivable gains. That opportunity cost is part of a successful hedge, not necessarily a trading failure.
Pricing and value
A fair forward price reflects spot price and relevant carry such as interest rates, dividends, storage, convenience yield, borrow, and contract terms. Initial value can be near zero even when notional is large. After inception, changing markets create positive value for one party and negative value for the other, introducing replacement-cost exposure.
Settlement and credit
Contracts can deliver the underlying or settle net in cash. Bilateral exposure depends on counterparty credit, netting, collateral, thresholds, and close-out terms. Currency forwards can require substantial gross settlement unless payment-versus-payment or netting applies. A profitable mark is not useful if the counterparty defaults when payment becomes due.
Risks and practical checklist
Forwards face counterparty, liquidity, basis, funding, collateral, settlement, legal, and operational risk. Confirm master agreement, confirmation, notional, price, dates, calendars, currency, settlement, netting, collateral, and termination. Independently value the contract and reconcile confirmations. Match hedge amount and timing to the underlying exposure and stress forecast error, early termination, default, and rolled positions.
Sources and further reading
- CFTC Glossary, U.S. Commodity Futures Trading Commission