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When looking at forward contracts and future contracts there is definitely a big difference. Yes, I am talking about bonds that are bought and sold on the the stock market all over the world on a daily basis. A bond is a debt instrument issued by a the federal government, corporations, municipalities, and foreign governments and corporations. A forward contract is when a corporation, the federal government, municipality, or foreign government buys goods ahead of time for a set price like say XYZ Inc. wanted to buy a forward contract on German electric motors and German motors wanted to sell say 100,000 electric motors for a specific price on a specific date in the future. Goods actually do change hands in a forward contract. There is a danger of default unless both parties involved are very strong financially. Perhaps the price of the commodity may change over the course of time.

The futures contract is similar to the forward contract except for three key differences: 1) Future contracts are "marked to market" meaning that the gains and losses are noted every day and money exchanges hands to cover the differences. This method of offsetting reduces greatly your default risk. 2) Goods never change hands with this type of contract. The 2 people simply settle up on the difference of the contract price and the actual price.

The 3rd difference between future and forward contracts is that a forward contract is usually negotiated and settled and not traded again on the exchange unlike future contracts that are repeatedly traded even after the initial purchase.

Ninety-five percent of all future and forward contracts are used to hedge an up and coming project a corporation may have coming up. To determine if you win or lose will be the interest rate in the open market. All securities are measured by the safest security of all, the T-bonds or Treasury bonds. If you buy treasury bonds at 8% for 10 years with a semi-annual coupon and the interest rate rises to 14%, you're obviously not getting your fair share on those dollars and if the interest rates goes up, then the T-bonds rates go down. Consequently, XYZ Corp. would sell futures to hedge deliverable in 6 months.

Learn more about this author, Jeffery Chandler.
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