What is a forward contract
A forward contract is a private agreement between two parties to buy or sell an asset at a price fixed today, with delivery and payment on a set future date.
It is a derivative, because its value depends on an underlying asset such as a currency, a commodity or a bond. Nothing changes hands at the start except the agreement. Both sides are bound. The buyer must buy and the seller must sell on the agreed date, whatever the market price is then.
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Forward contract example
This is a hypothetical case with no real rates.
- A Karachi importer must pay a US supplier in dollars a few months from now.
- The importer worries that the rupee may weaken before then.
- Today the importer agrees a forward with its bank. On the delivery date it will buy the dollars at a fixed PKR-per-USD rate set now.
Two outcomes are possible on the delivery date:
| Spot rate on delivery date | Result for the importer |
|---|---|
| Higher than the forward rate | Pays less than the spot rate. The forward protected it. |
| Lower than the forward rate | Still pays the forward rate, which is more than spot. |
The forward removes uncertainty. It does not guarantee a better price. The forward rate is usually the spot rate adjusted by forward points, which reflect the interest-rate difference between the two currencies. This link is called covered interest parity.
Precise definition and details
- Over-the-counter (OTC). A forward is negotiated directly between the two parties, not on an exchange. Amount, date and settlement terms can be set to fit each case.
- Counterparty risk. Each side depends on the other to perform. If one party defaults, the other loses the protection. See counterparty. Banks often manage this risk with credit lines or collateral.
- Settlement. A deliverable forward ends with an actual exchange of the asset. A non-deliverable forward (NDF) is settled in cash for the difference between the forward rate and a reference rate, usually in a freely convertible currency. See cash vs physical settlement.
- Valuation. Before maturity, a forward has a mark-to-market value: the gain or loss it would show if it were closed at the current forward rate.
- Early close. Ending or changing a forward before its expiry date is a new negotiation and can carry a cost.
- Forward vs futures. A futures contract is standardised, trades on an exchange and is cleared through a central counterparty with daily margin. A forward has none of these features. Rolling a futures position is covered in futures roll.
Where you see the term
- Bank FX desks quote "outright forward" rates and forward points to importers and exporters who want to manage currency risk.
- Company annual reports list "forward foreign exchange contracts" under derivatives or hedging, usually shown at fair value.
- News reports on forward premiums, or on NDF markets for currencies with capital controls.
- Commodity analysis uses forward and futures prices to describe contango and backwardation.
On retail trading platforms, most forex CFDs track spot prices rather than forwards. Leveraged CFD and forex trading can lose money fast.
Related terms
Forward points, derivatives, counterparty, front month, contract size. For more terms, see the trading glossary.
Frequent questions
What is a forward contract in simple words?
It is a deal made today to exchange something later at a price fixed now.
Is a forward contract the same as a futures contract?
No. A forward is private and can be customised. A futures contract is standardised, traded on an exchange and margined daily.
Can a forward contract lose money?
Yes. If the market moves in your favour, you still must trade at the agreed price. If the other party fails to perform, you can lose the protection the contract was meant to give.
What is a non-deliverable forward?
It is a forward settled in cash for the price difference, with no delivery of the underlying currency.