Future Contract vs Forward Contract

Dear sir, first of all thank you for this opportunity. My question is about hedging instrument.  What is the difference between future contract and forward contract?

KADHAFI from Rwanda (Africa)

Kadhafi! Both future contract and forward contract are simplify the contract. We know the contract is the agreement in which goods and services are provided on the basis of money consideration. But sometime, we see fluctuations in the market. It may be due to changing of prices or increase or decrease of quantity of goods or services. At that time both future contract and  forward contract will be helpful. But still following are basic difference between future contract and forward contract.

In future contract, one party buys the goods or service on today price but delivery will be completed in future date. If prices will increase, buyer will get profit from future contract because he will get right of delivery on the past contract price.

For example, today is 7/3/2012 and I contracted with a building material shop for 1000 bricks, today price is Rs. 4 per brick. I contracted for getting delivery on 17/3/2012 at same Rs. 4 per brick. For example, if the price of per brick will reach at Rs. 10 on 17/3/2012. I will pay just Rs. 4 per brick. On this basis, I will just pay Rs. 4000 instead of Rs. 10000. This is simple example of future contract. With this, I will get benefit of Rs. 6000.

In forward contract, buyer agrees to buy product in future date at today price but with the condition that he will sell same product on the price which is fixed today.  Actually, in forward contract nothing assets is exchanged but only profit and loss is exchanged.

 Very Good Example of Wikipedia for Learning Forward Contract
Suppose that Bob wants to buy a house a year from now. At the same time, suppose that Andy currently owns a $100,000 house that he wishes to sell a year from now. Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of $104,000 (more below on why the sale price should be this amount). Andy and Bob have entered into a forward contract. Bob, because he is buying the underlying, is said to have entered a long forward contract. Conversely, Andy will have the short forward contract.
At the end of one year, suppose that the current market valuation of Andy's house is $110,000. Then, because Andy is obliged to sell to Bob for only $104,000, Bob will make a profit of $6,000. To see why this is so, one needs only to recognize that Bob can buy from Andy for $104,000 and immediately sell to the market for $110,000. Bob has made the difference in profit. In contrast, Andy has made a potential loss of $6,000, and an actual profit of $4,000.

Vinod Kumar

Educator

Prof. Vinod Kumar is an Indian Educator, Motivational Speaker, Naturopathic Practitioner and Entrepreneur . He is the founder of Svtuition... read more »

2 comments:

  1. Sandipan ChattopadhyayMarch 22, 2012 at 11:11 PM

    Very nice explanation. Truely effective and I am becoming a fan of SV Tuition...Thanks and keep up this good work..

    ReplyDelete