A forward contract is made directly between two parties. In a physically delivered forward contract one party agrees to buy an underlying commodity or financial asset on a future date at an agreed fixed price. The other party agrees to deliver that item at the stipulated price. Both sides are obliged to go through with the contract, which is a legal and binding commitment, irrespective of the value of the underlying at the point of delivery. Some forward contracts are cash-settled rather than through the physical delivery of the underlying. This means that the difference between the fixed price stipulated in the contract and the actual market value of the underlying commodity or financial asset at the expiry of the contract is paid in cash by one party to the other. Since forwards are privately negotiated, the terms and conditions can be customized. However, there is a risk that one side might default on its contractual obligation unless some kind of guarantee can be put in place.

Categories: Derivatives


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