A forward contract is an agreement in which two parties agree to buy or sell a specific financial product, such as a commodity, currency or index, at a future date for a predetermined price. The price is fixed today, while delivery or settlement takes place later.
image_here
A forward contract provides certainty about a future price, but it binds both parties to the agreement.
Forward contracts are widely used to hedge risks. Producers, traders and investors seek protection against unexpected price fluctuations. By agreeing on a price in advance, they know where they stand financially. At the same time, forward contracts can also be used to speculate on price increases or decreases.
Depending on the type of contract, settlement may take place physically, where the product is actually delivered, or financially, based on the price difference. Because the value of the contract moves with the market price, profits and losses can increase quickly. This makes risk management important when using forward contracts.
Short example:
Suppose a grain farmer expects to harvest 10,000 kilos of wheat in six months.
Today, he enters into a forward contract to sell that wheat in six months for €200 per ton.
If the market price falls to €170 per ton by then, he is protected against the price loss. If the price rises to €230 per ton, he does not benefit from the higher market price because the selling price has already been fixed.
Disclaimer: Investing brings risks. Our analysts are not financial advisors. Always consult an advisor when making financial decisions. The information and tips provided on this website are based on our analysts' own insights and experiences. Therefore, they are for educational purposes only.