In finance, a forward contract is a contract where two parties agree to a transaction where an asset will be transferred at a specified future time at a pre-specified price. The pre-specified price is called the delivery price. The delivery price is equal to the forward price at the time the contract is entered into by the two parties.

Basic info about forward contracts

  • A forward contract is a type of derivative instrument. It t is often referred to simply as a forward rather than a forward contract.
  • The party agreeing to transfer ownership of the asset to the other party assumes a short position. The party agreeing to purchase the asset from the other party assumes a long position.
  • Forward contracts are non-standardized contracts, which makes it extra important to really read and understand everything in the forward contract before you enter into such a contract.
  • Forwards are used both for speculation and for hedging. Hedging is a type of risk mitigation. Forwards are often used to hedge currency risk and interest rate risk.

The forward market

As mentioned above, forwards are non-standardized contracts. As a consequence, they are not traded on exchanges but over-the-counter (OTC). This is one of the major differences between forwards contracts and futures contracts.

The forward market highly customized and each party need to take counterparty risk into account since the contracts aren’t renovated.

What is a non-deliverable forward?

forwardsA non-deliverable forward (NDF) is a forward contract where no asset can be delivered. The counterparts agree to settle the difference in cash (typically USD) or similar. NDF:s are normally short-term forwards.

NDF:s exists on several markets, such as the forex market and the commodity market. In some countries, NDF:s are used to circumvent laws that bans forex trading.

NDF:s are traded over-the-counter (OTC).

Examples of currencies for which there are well-established NDF markets are the South African Rand, the Brazilian Real, the Chinese Renminbi, the Taiwan Dollar, the South korean Won, the Indian Rupee and the Israeli Shekel.

What is a forward to forward contract?

A forward to forward contract is a swap transaction that consists of the simultaneous sale and purchase of one currency for another. Both transactions are forward contracts.

The forward to forward contract is typically employed by a company or other entity that wish to benefit from the forward premium without locking on to the spot rate.