Definition: The Future Contracts are the standardized Forward Contracts wherein two parties mutually decide to sell or buy the underlying asset at a predefined future date and at a price locked today. These are considered as a less risky alternative of hedging against the currency market fluctuations.
If the future contracts are the forward contracts, then why it is considered as a separate tool of hedging? Well, these contracts do look alike but are different from each other. These differences are explained in the points given below:
- The forward contract is a more customized contract wherein the terms are negotiated between the buyers and sellers, whereas the future contract is a standardized contract where, date, quantity, and delivery conditions are standardized.
- The forward contracts have no secondary markets while the future contracts are traded on the organized exchange.
- In the case of a forward contract, usually, no collateral is required, whereas, in the case of a future contract the margin is required.
- The final settlement of the forward contracts is done on its maturity, whereas the future contracts are “marked to market” on a daily basis, which means the profits and losses of these contracts are settled daily.
- The forward contracts often end with the deliveries, whereas the futures are mostly settled with the differences.
Thus, it is quite clear from the above comparison that both the forward contracts and future contracts are different from each other and are used for different purposes.