Forward Contract Definition Investopedia

A forward contract is a type of financial contract between two parties to buy or sell an asset at a specified price and date in the future. The value of the contract is determined at the time the contract is entered into, and the transaction is settled on the predetermined date. Forward contracts are used to manage risks associated with fluctuations in asset prices and are commonly used in the commodities markets.

In a forward contract, the buyer agrees to purchase the asset at a set price on a specific date in the future. The seller, on the other hand, agrees to sell the asset at the agreed-upon price on the date specified in the contract. The price of the asset is determined at the time the contract is entered into, which means that the parties know exactly what price will be paid or received for the asset at the end of the contract term.

Forward contracts can be used to hedge against price changes, as they lock in the price of the asset for a specified period of time. For example, a farmer who expects to harvest a crop in six months might enter into a forward contract to sell the crop at a specified price. This allows the farmer to protect against the risk of a drop in crop prices over the next six months.

Forward contracts are different from futures contracts, which are similar but operate in a centralized marketplace. In a futures contract, the buyer and seller are not known to each other, and the transaction is standardized and guaranteed by an exchange.

One potential drawback of forward contracts is that they are not easily transferable. If one party wants to get out of the contract before the end date, they may need to find another buyer or seller who is willing to take over the contract. This can be difficult in some markets, especially if the asset being traded is not very liquid.

In summary, a forward contract is a financial contract between two parties to buy or sell an asset at a specified price and date in the future. It is used to manage risks associated with fluctuations in asset prices and is commonly used in the commodities markets. While forward contracts offer some benefits, they can also be difficult to transfer and are therefore not suitable for all investors.