Future and Forward Contracts

One of the most widespread financial instruments are futures contracts and forward contracts. A
futures/forward agreement is an agreement that determines the price and date of a future transaction
for buying or selling an underlying asset. Nevertheless, they also differ with respect to their specific
characteristics. The futures contracts are predefined expresses traded on organized exchanges, such as
the Chicago Mercantile Exchange (CME), while the forward contracts are tailored expresses negotiated
bilaterally between the parties. The standardization of futures contracts would make them much easier
to liquidate and trade compared to forwards (OTC). Also, futures contracts involve lower counterparty
risks since the exchange acts as an intermediary guaranteeing the performance of both parties while the
forward contracts on the other hand involve higher counterparty risks, which can only be settled relying
entirely on the creditworthiness of the parties involved. As opposed to forward contracts which can be
further tailored to match specific demands, futures contracts bring the advantage of standardization
thus, resulting in higher liquidity and ease of trading. Differently from the per-day settlement on the
futures, forward contracts are settled at the end of the contract term; for this reason, futures contracts
are usually settled through marking-to-market. More importantly, though, futures contracts are subject
to government agency regulation, for example there is the Commodity Futures Trading Commission
(CFTC), whereas forwards contracts are not regulated as strictly. There is an argument that alongside the
flaws, they also help in specific ways like risk management, currency or price of assets.