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A forward contract (also referred as “Forward”) is a customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging.
Unlike standard futures contracts, a forward contract can be customized to a commodity, amount, and delivery date. Commodities traded can be grains, precious metals, natural gas, oil, or even poultry. A forward contract settlement can occur on a cash or delivery basis.
Forward contracts do not trade on a centralized exchange and are therefore regarded as over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher degree of default risk.
Both forward and futures contracts involve the agreement to buy or sell a commodity at a set price in the future. But there are slight differences between the two. While a forward contract does not trade on an exchange, a futures contract does.
Settlement for the forward contract takes place at the end of the contract, while the futures contract settles on a daily basis. Most importantly, futures contracts exist as standardized contracts that are not customized between counterparties.