Forward and Futures Contracts

Forward Contracts

Definition:  A forward contract is a commitment to purchase at a future  date a given amount of a commodity or an asset at a price agreed on today.

• The price fixed now for future exchange is the forward price
• The buyer of the underlying is said to be "long" the forward
  

Features of Forward Contracts

• Customized
• Non-standard and traded over the counter (not on exchanges)
• No money changes hands until maturity
• Non-trivial counter party risk

Example:

• Current price of soybeans is $160/ton
• Tofu manufacturer needs 1,000 tons in 3 months
  
• Wants to make sure that 1,000 tons will be available
  
• 3-month forward contract for 1,000 tons of soybeans at $165/ton
  
• Long side will buy 1,000 tons from short side at $165/ton in 3 months