What is the Difference Between Forward and Futures?

The main differences between forward and futures contracts are as follows:

1. Trading Platform: Forward contracts are privately negotiated between two parties and traded over-the-counter (OTC), while futures contracts are standardized and traded on an exchange.
2. Standardization: Futures contracts have standardized terms, such as contract unit, expiration date, tick size, and notional value, while forward contracts are customized to the needs of the parties involved.
3. Regulation: Futures contracts are regulated by the Commodity Futures Trading Commission (CFTC) and backed by clearinghouses, which provide institutional guarantees and reduce counterparty risk. In contrast, forward contracts are not formally regulated and rely on the creditworthiness of the counterparties for performance.
4. Counterparty Risk: Forward contracts carry a higher counterparty risk, as the obligations depend on the credit standing of the parties involved. In futures contracts, the counterparty risk is almost nil, as the exchange clearinghouse guarantees the performance.
5. Daily Centralized Clearing and Mark-to-Market: Futures contracts require daily centralized clearing and mark-to-market, which means that the profit or loss from the change in the contract's value is settled daily. This is not the case for forward contracts.

In summary, forward contracts are customized, privately negotiated, and OTC-traded agreements between two parties, while futures contracts are standardized, exchange-traded, and regulated agreements with reduced counterparty risk.

Comparative Table: Forward vs Futures

Here is a table summarizing the differences between forward and futures contracts:

In summary, forward contracts are customizable and traded privately between two parties, while futures contracts are standardized and traded on exchanges. Forward contracts carry higher counterparty risk, whereas futures contracts have lower risk due to exchange regulation and standardization.