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Community User Posted on 02:59pm 14-Nov-2019

What is a Futures contract and how is it different from a Forward contract?

Derivatives can be generally of 2 types - Over the Counter (OTC) and Exchange Traded. OTC derivatives are less refined in nature as contract terms are mostly customized in comparison to Exchange traded which captures all standardized terms and conditions. Futures Contract is an example of exchange traded derivative instruments and Forward contract is an example of OTC derivative.
 
In futures contract, the buyer and seller agree to buy and sell specific amount of underlying asset at a future date at a particular price. So, all the contract specifications are standardized as per the exchange on which it is tradable. Therefore, the exchange guarantees the trade settlement in case of future contract.  On the other hand, forward contract is a customized contract (OTC) where buyer and seller themselves decide the contract specifications with no central counterparty between the two.
 

Point of Distinction

Forward Contract

Futures Contract

Contract Terms

Customized

Standardized

Risk of Default

High

Low

Regulation

Self-Regulated

Stock Exchange

Initial Margin

Not Required

Required

Settlement

On Expiry Date

Daily basis

 
Therefore we can say a futures contract is like a standardized forward contract.
 
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