By the FinLingo Team | Capital markets practitioner, front office experience at a major European investment bank. FinLingo covers 342 lessons from bonds to exotic derivatives. About · Last updated:
A forward contract is a private agreement between two parties to buy or sell an asset at a specified price on a future date. Unlike options, both sides are obligated. The buyer agrees to purchase, the seller agrees to deliver, and no money changes hands until settlement. Forwards are the simplest derivative — and the foundation for understanding all others.
The forward price is not a forecast of the future spot price. It is the only price that prevents arbitrage between the spot and forward markets. For a non-dividend-paying asset: F = S · e^(rT), where S is the spot price, r is the risk-free rate, and T is time to maturity. This is a mathematical identity, not a prediction.
A stock trades at $100. The risk-free rate is 5%. The 1-year forward price is $100 × e^(0.05 × 1) = $105.13. If the forward traded at $108, an arbitrageur would sell the forward, borrow $100, buy the stock, and lock in a $2.87 profit at expiry. If the forward traded at $103, the arbitrageur would do the reverse. This arbitrage mechanism pins the forward to its theoretical value.
A future is a standardised forward traded on an exchange. Three key differences. First, futures have daily margin settlement (mark-to-market) — gains and losses are settled every day, not at maturity. Second, futures are standardised in contract size and expiry dates. Third, futures carry no counterparty risk because the exchange clearinghouse guarantees performance. Forwards are customised, bilateral, and carry counterparty risk.
If the underlying pays income (dividends, coupons) or has a continuous yield q, the forward price adjusts: F = S · e^((r−q)T). Higher carry costs (storage, funding) raise the forward price. Income (dividends, convenience yield) reduces it. This carry-cost framework underpins forward pricing across equities, FX, commodities, and fixed income.
A forward contract is an agreement between two parties to buy or sell an asset at a fixed price on a specific future date. Unlike an option, both sides must follow through. No money changes hands until the settlement date. It is the simplest type of derivative and is used for hedging and speculation.
By the no-arbitrage principle. The forward price equals the spot price compounded at the risk-free rate: F = S times e to the power of rT. If the forward traded above or below this value, arbitrageurs would exploit the discrepancy until the price corrected. The formula adjusts for dividends, storage costs, or convenience yield on the underlying.
A future is a standardised, exchange-traded version of a forward. Futures have daily margin settlement, standard contract sizes, and are cleared through a central counterparty (eliminating counterparty risk). Forwards are private, customisable, settled at maturity, and carry bilateral counterparty risk. The pricing is nearly identical, with small adjustments for the margin settlement timing.
FinLingo covers forwards and futures in Level 2 — 7 units from mechanics to pricing with income and yield. Level 1 is free.
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