Question

Forward contracts and futures contracts have similar functions and different features. Among those features are the fact that while forward contracts are closed out by specific performance, futures contracts are almost never closed out that way. Why not? Since the contracts are closed out in different ways, it is implied that the parties to these contracts have different goals. What types of entities get involved in each? How might their goals differ?

Answer 1

Forward contract and future contracts are different because of following reasons-

A. Forward contracts are generally customised contracts and these contracts can be modified according to the need of the individual but futures contract are always standardized contracts and they will not be customised.

B. future contracts are not closed out because they are never customised contracts and they have been standardized whereas forward contracts will always be customised and closed upon the performance

C. There will be high level of counterparty risk associated with the forward contract whereas there is almost negligible risk in terms of counterparty risk in case of future contracts

D. Forward contracts are generally offering low level of transparency as they are not traded on the exchange whereas future contracts are continuously traded on the exchanges and they will be offering a very high level of transparency

E. forward contracts are over-the-counter exchange contracts whereas future contracts will be trading upon the exchange.

So, Due to these reasons, various entities are following these contracts as they want to hedge their exposure but it will be having difference in their approaches.