Forward contracts

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A forward contract is a private, cash-market agreement between a buyer and seller for the future delivery of a commodity at an agreed upon price. Unlike futures contracts, forward contracts are not standardized and not transferable.[1] A clearing house does not stand between buyer and seller to guarantee performance of a forward contract.[2]

A non-deliverable forward is a cash-settled, short-term forward contract on a foreign currency or commodity, where the profit or loss at the settlement date is calculated by taking the difference between the agreed upon exchange rate and the spot rate at the time of settlement, for an agreed upon notional amount of funds. NDFs are often used in circumstances where there is low liquidity, such as to hedge local currency risks in emerging markets where local currencies are not freely convertible, or when there are restrictions on capital flows.[3]

History

Standardized forward contracts were essentially the first futures contracts.

According to CME Group's educational resources, in 1848 the Board of Trade of the City of Chicago was formed as a member-owned organization that offered a centralized location for cash trading of a variety of goods as well as trading of forward contracts. As business grew, it was decided that standardizing the contracts would streamline the trading and delivery processes.

Market participants were asked to trade contracts that were identical in terms of quantity, quality, delivery month and terms as established by the exchange. The only thing left for traders to negotiate was price and the number of contracts.[4]

References

  1. Glossary of Terms - Forward contract. CME.
  2. Primer - Derivative Instruments. Financial Policy Forum.
  3. Non-Deliverable Forward. Financial Times Lexicon.
  4. History of Futures. CME.