Concepts of Forward Contract

A forward contract is a simple customized contract between two parties to buy or sell an asset at a certain time in the future for a certain price.

Unlike future contracts, they are not traded on an exchange, rather traded in the over-the-counter market, usually between two financial institutions or between a financial institution and one of its clients.

In other words, it is a privately negotiated contract that is not conducted in an organized marketplace or exchange. Both parties to a forward contract expect to make or receive delivery of the commodity on the agreed-upon date.

It is difficult to get out of a forward contract unless the other party agrees. All forward contracts specify quantity, quality, and delivery periods.

Thus, a forward contract is an agreement to buy (or sell) an asset at a preset price on a future date. At maturity, if the actual price (spot price) is higher than the contracted price, the forward buyer makes a profit.

If the price is lower, the buyer suffers a loss. The pay-off to the seller is the opposite of that of the buyer.

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