Forward contract - Definition and Overview

A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. Beside other instruments, such as Options or Futures, it is used to control and hedge risk, for example currency exposure risk (e.g. forward contracts on USD or EUR) or commodity prices (e.g. forward contracts on oil). The forward price will usually give a good market estimation of the price in the future.

One party agrees to buy, the other to sell, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collaterised, exchange of margin will take place according to an pre-agreed rule or schedule. Otherwise no asset of any kind actually changes hands, until the maturity of the contract.

The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands (on the spot date, usually next business day). The difference between the spot and the forward price is the forward premium or forward discount.

See also

• Derivative securities
• Forward market
• Futures contract (a form of forward contract that has been standardised for a wide range of uses)
• Hedging
• Options
• Futures
• Swaps