A forward contract is a particular simple derivative. It is an agreement to buy or sell assets at a certain future time for a certain price. A forward contract can be contrasted with a spot contract, which is an agreement to buy or sell an asset today. It is traded in the over-the-counter market. Usually between two financial institutions or between a financial institution and one of its clients.
One of the parties to a forward contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price.
Payoff from long position
short position payoff
How forward contracts works
A forward contract specify the delivery of security at some future date.A forward price determined at the time the contract entered into and it is a set at a level so that the contract has no initial monetary value .
The parties to this, the buyer and the seller retain the flexibility to designate the grade and the quantity of the goods to be delivered as well as the time and place of delivery.
Forward vs Future contract
A futures contract has essentially the same characteristics as a forward cbut differs in four aspects that affect the ease with which traded relative to this.
Both contracts are agreements to buy or sell an asset for a certain price at a certain future time. A forward contract standardized contract traded on an exchange.
Forward v/s future contract
1)Forward contracts traded on over the counter market.
Future contract traded on an exchange.
2)Forward contract, not a standardized contract.
Future contract standardized contract.
3)Forward contract has unspecified delivery date.
Future contract has range of delivery date.
4)Forward contract settled at end of contract
Future contract settled daily.
5)Final cash settlement usually takes place.
Contract usually closed out prior to maturity.