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What are forward contracts?

What are forward contracts?

Forward contracts are agreements to exchange specific assets on a specific date, at a price determined at the outset.

Forward contracts are similar to futures contracts, but they are over-the-counter private contracts drafted for specific purposes, quantities, and dates that satisfy the specific needs of the counter-parties. These contracts are mostly entered into by institutional investors seeking a hedge against risks such as interest rates and exchange rates.

The price or rate struck on the contract will be the price or rate used at the delivery date, but if it differs too much from the spot price or rate at the settlement date, the risk of a party defaulting on the agreement rises.

While futures contracts are marketable, forward contracts are not.

Keywords: over-the-counter (OTC), counter-parties, spot rate, forward contracts,