How are futures and forwards different? State at least 2 properties or conditions.
Question
How are futures and forwards different? State at least 2 properties or conditions.
Solution
Futures and forwards are both types of derivative contracts that allow for the buying or selling of an asset at a specific price at a future date. However, they differ in several ways:
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Trading Location: Futures contracts are traded on an exchange, which means they are standardized contracts. On the other hand, forwards contracts are private agreements between two parties and are not traded on an exchange.
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Level of Risk: Futures contracts are generally considered to be riskier than forwards contracts. This is because futures are more volatile and the investor must have a margin account with the broker. With forwards, the risk is only on the counterparty, so there is no need for a margin account.
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Settlement: Futures contracts are settled daily, meaning the change in value of the contract is calculated each day and profits or losses are credited or debited to the investor's account daily. Forwards contracts are not settled until the end of the contract.
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Customization: Futures contracts are standardized, meaning they have a fixed size and expiration date. On the other hand, forwards contracts can be customized to any size and with any expiration date that the buyer and seller agree upon.
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Delivery: In futures contracts, the commodity is usually not delivered but the contract is closed out before maturity. In forwards, the commodity is usually physically delivered on the maturity date.
Similar Questions
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Which of the following statements about futures are true:I. Futures is a standardised contract to buy or sell a specific commodity or financial instrument at a specific price at a predetermined future date;II. In Australia bonds futures are usually quoted at an index figure of 100 minus the yield so a dealer can follow a basic principle of buy low and sell high;III. Novation is the process to renew futures contracts when they fall due;IV. Standard delivery is more usual in futures markets.
Which of the following is a key advantage of futures contracts over forward contracts? A. Customizable terms B. Lack of counterparty risk C. Standardized terms D. Settled at the discretion of the parties involved
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