FORWARDS: Commodity, Currency, Interest Rate, and Equity Contracts

Forwards are non-standardized contracts which are traded Over-the-Counter (OTC). They are similar to swaps in trading over-the-counter, being vulnerable to credit party risks, requiring exact offsets, and lacking the anonymity of futures contracts.

Forwards are similar to futures in that there is a contractual price, here, the forward price. Also, deliveries or settlements are to be made on or before a known date. It should be noted that forwards stipulate a settlement, termination or forward date. However, offsets may be made before that time but may be subject to illiquid conditions.

Simple forward contracts have a long position (purchase or buyer) and a short position (sale or seller). Terms are established at the onset of the contract and settlement is required when the contract is offset.

Forwards are common in the currency markets or bank forward markets. Depending on the counterparties there may be wide variations in required margining practices. Often, bank-to-bank transactions are not margined and settlements made on the maturity date.

In the currency markets (yen, euros, sterling and so on), the relationship between the prices is partially determined by the relative yield curves, interest rate diffferentials, and other market conditions. If the forward price for a currency is below the spot price, that currency is said to be at a discount or considered "weaker."

If the forward price for the currency is higher than the spot, then that currency is said to be at a premium or considered "stronger."

Generally, forward contracts are used for risk management purposes such as locking in prices and/or supplies.

It should be noted that futures are often used to adjust some risk exposures or profiles of existing forwards.

For more information, this online site contains many references for Derivatives. The following listing highlights some of these reference resources.

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