Forward Contract

With a forward contract, the price and date are agreed today, but payment and delivery happen later. Both parties are obliged to complete the deal, regardless of the market price on the delivery date.

Forwards are traded over the counter, directly between parties, often a business and a bank. This means they can be tailored to the exact amount, date and terms needed.

For example, a company that must pay a supplier 1 million euros in three months might agree a forward contract with its bank to buy euros at 1.10 dollars each. In three months, it pays 1.1 million dollars and receives 1 million euros, even if the market rate has moved to 1.15 or 1.05.

Forwards are widely used to hedge currency, commodity and interest rate risks. Their main drawback is counterparty risk: because they are private agreements, one party could fail to honour the contract. They are also usually hard to cancel or transfer before maturity. Futures contracts, which trade on exchanges, reduce some of these drawbacks but are less flexible.