Despite the fact that both a futures and forward contract perform the same function, namely being designed to allow people or organizations to buy or sell an explicit asset at a specified time in the future, with the price being determined at the date the contract is signed, there are differences between them, which tends to determine their particular usage. Essentially, these can be identified within three main areas.

1. The contract

A futures contract can only be traded through an exchange and facilitated through clearing houses. These contracts come with a set standard of terms and conditions as laid down by the exchange. However, a forward contract can be made between any two people or organizations and are traded across the counter with no exchange control involved.

2. The Settlement

The two forms of contracts are also settled in noticeably different ways. The loss or gain on a futures contract is settled by the exchange or cleaning house on a daily basis, with that loss or gain being deducted or added to the relevant parties account. A forward contract does not become due for settlement until the term of the contract has expired. To example this, a six month futures contract will have the daily loss or profit paid out or withdrawn every day for the six month period. The buyer of a six-month forward contract will not have to pay the agreed sum until the last day of those six months.

3. The Use

In reality, investors who are speculating are the main users of futures contract. In this instance they are betting for or against a rise in price of the asset denoted within the contract. For example, if a speculator believes the price of a stock market index is likely to rise, they will buy at an agreed price now. If the price does rise, the settlement of the contract will leave them with a profit. However, futures contracts are rarely held for the full term as the parties will close the contract when they have made the profit they desire or to stop further losses.

A forward contract is used for hedging (or protecting) purposes and is likely to be held for the complete term and settled in full. In this case, the buyer may be purchasing an asset or goods at an agreed future price, hoping that when the contract is realized they will have saved themselves any price increase that product has incurred during the term.

Because of these differences, it can be seen that there is a greater risk of default on a forward contract, whereas the futures one has a level of guarantee attached to it, reducing the risk considerably.

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