Question

What factors distinguish a forward contract from a futures contract? What do forward and futures contracts have in common?

What advantages does each have over the other?

Answer 1

The factors that distinguish a forward contract and a futures contract are:

• The futures contracts are traded on the exchange, while the forward contracts are traded on OTC (over the counter)
• The futures contracts are standardized, while the forward contracts can be customized
• There may be counterparty risk in forward contracts. There will be no counterparty risk in the futures contract. The risk is covered by the clearinghouse.

The things that both forward and futures contracts have in common are:

1. Both the parties in the contracts have an obligation to either deliver or take delivery of the underlying assets
2. Initial margin is required to be deposited in both the contracts

The advantage of the futures contract is that it has no counterparty risk.

The advantage of the forward contract is that it can be customized.