THE DIFFERENCE BETWEEN A FORWARD CONTRACT AND A FUTURES CONTRACT
Forward contracts and futures contracts are derivatives used by Corporations, Banks, and Speculators to compensate the fluctuations in the exchange rate market.
The biggest difference between the forward contract and the futures contract is the expiration of the contract. A forward contract can be set a year or more in advance with a specific date and price. The futures contract expires at the end of a trading day.
When companies do business with other companies worldwide they must pay for their products with the other company’s currency. Therefore if there is depreciation in the dollar, a company could be in trouble if it did not have a means to compensate for this fluctuation in price. The futures contract or the forward contract becomes the lifesaver for the cash flows and profits of the company.
Every country has a certain exchange rate. To understand this think of the US dollar. The currency of a given country may either appreciate or depreciate against the dollar. Currencies of one country can appreciate or depreciate against the currency of another country. The exchange rates for every country change every day.
Multinational corporations trade in payables and receivables according to the exchange rates of their respective countries. They also trade in the millions and billions of dollars.
So that if US Corporation XYZ is trading with Japanese Corporation ABC we have a difference in currency called the exchange rate. $1,000,000 dollars will be worth more or less in Yen. In order to compensate for the difference a forward contract can be set up to make a specific buy or sell at a specific date. This way the corporation is assured of protection against depreciation.
This may also be done with the futures contract, which is standardized. Futures contracts can be made in smaller amounts and are regulated by the Commodity Futures Trading Commission and the National Futures Association. Forward contracts are self-regulating, and private.
Forward contracts are a private deal between two entities that know and trust each other. They conduct their agreement by telephone. There is no security deposit or brokerage fee. Liquidation is by delivery. Futures contracts are traded on the central exchange floor of an exchange clearinghouse. There is a small security deposit and a brokerage fee. Liquidation is by offset.
A fraction of the currency of a country can mean profits for large corporations, banks, and speculators when dealing and speculating in millions and billions of dollars,
Forward and futures contracts are normally not for the ordinary consumer or citizen who can not negotiate in the millions and billions of dollars.
For more information on exchange rates you can use the Currency Converter at http://finance.yahoo.com/currency?a=1&s=USD&t=PHP