Forward Contract
A forward contract is a private agreement to buy or sell an asset at a set price on a future date. Unlike futures, forwards are customised, not standardised, and are traded over the counter rather than on exchanges.
An importer knows it must pay €1 million in three months and doesn't want to gamble on exchange rates. A forward contract lets it lock in today the rate it will pay later. Forwards are among the oldest and most widely used derivatives, especially in currencies and commodities. This entry explains how they work, how they differ from futures and their risks.
- Category
- Derivatives
- Reading time
- 3 min
- Also called
- Forward, Forwards, Currency forward
- Updated
Forwards in plain words
A forward contract is an agreement to buy or sell an asset at a specific price on a specified future date.1
The buyer holds a long position and the seller a short position.1
Forward contracts are not standardised and are not traded on organised exchanges.2
How a forward works, step by step
Agree the terms
Asset, amount, price, date.
No upfront payment
Usually nothing changes hands at the start.
Value changes over time
As the market price moves.
Settle at maturity
Deliver the asset or pay the difference in cash.
Counterparty risk
The other side might not pay. See Counterparty Risk.
Hedge or speculate
Lock in prices or bet on them. See Hedging.
Worked examples
Example 1 — Currency hedge
$50,000 savedA US importer agrees to buy €1,000,000 in 3 months at $1.10. At maturity the spot rate is $1.15.
| Cost with forward | $1,100,000 |
| Cost without | $1,150,000 |
| Saving | $50,000 |
Locking in a price today removes uncertainty about the future cost. See Currency Risk.
Example 2 — The other side
Paid more than spotSame forward, but the euro falls to $1.05 at maturity.
| Cost with forward | $1,100,000 |
| Spot cost | $1,050,000 |
| Opportunity cost | $50,000 |
A forward obliges both sides; the hedger gives up gains to avoid losses.1
Example 3 — Long payoff
+$6,000You agree to buy 1,000 barrels of oil in 6 months at $80. Spot at maturity is $86.
| Payoff | ($86 − $80) × 1,000 = $6,000 |
The long side gains when the price at maturity is above the agreed price.1
Forwards vs futures
| Aspect | Forward | Futures |
|---|---|---|
| Terms | Customised | Standardised |
| Where traded | Over the counter | On exchanges |
| Settlement | Usually at maturity | Daily mark-to-market |
| Counterparty risk | Higher | Lower (clearing house). See Futures Contract |
Who uses forwards
Importers and exporters
Locking exchange rates. See Forex Market.
Commodity producers
Fixing sale prices. See Commodities.
Investors
Hedging foreign holdings. See Currency Risk.
Banks
Market-making in forwards. See Forward Points.
Advantages and disadvantages
Advantages
- Fully customisable.
- No upfront cost in most cases.
- Effective hedge for known exposures.
Disadvantages
- Counterparty risk.
- Hard to exit before maturity.
- Less transparent pricing.
Going deeper
Read as far as you need. Each level builds on the one before it.
Not exchange-traded
Beginner
Because forwards aren't standardised or exchange-traded, each one is a private deal between two parties.2
Forward pricing
Intermediate
Forward prices reflect the spot price adjusted for interest rates and carrying costs; in FX this shows up as forward points. See Forward Points.
Non-deliverable forwards
Advanced
For restricted currencies, non-deliverable forwards settle the difference in cash instead of exchanging currencies. See Non-Deliverable Forward.
Common mistakes
Ignoring counterparty risk
Check who's on the other side.
Over-hedging
Hedge only real exposures.
Forgetting the obligation
Unlike options, forwards must be settled.
Assuming easy exit
Unwinding can be costly.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- A forward fixes a price for a future trade.
- It's customised and traded over the counter.
- Both sides are obligated.
- Hedgers give up upside to remove risk.
- Counterparty risk is the main drawback.
Frequently asked questions
Do you pay anything upfront for a forward?
Can I cancel a forward?
Are forwards regulated?
Further learning
- Futures Contract
The exchange-traded cousin.
- Forward Points
How FX forwards are priced.
- Hedging
The main use.
- Counterparty Risk
The key risk.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Forward Contract (opens in a new tab) Checked .
- Nasdaq. Forward contract (glossary) (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.