Compare and Contrast Forwards and Futures

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The Answer is Forwards and futures are both types of financial contracts that allow parties to buy or sell an asset at a specified price on a future date. However, there are some key differences between the two.

Forwards are private agreements between two parties to buy or sell an asset at a specified price on a future date. They are customizable and can be tailored to the specific needs of the parties involved. Forwards are traded over-the-counter (OTC), meaning they are not traded on an exchange and are not standardized.

Futures, on the other hand, are standardized contracts that are traded on an exchange. They specify the quantity and quality of the underlying asset, as well as the delivery date and location. Futures contracts are more liquid and easily tradable compared to forwards.

Another difference is the way they are settled. Forwards are settled at the end of the contract, meaning the buyer and seller exchange the asset and the payment on the specified future date. Futures, on the other hand, are often settled on a daily basis through a process called marking to market, where gains and losses are settled daily.

In terms of counterparty risk, forwards carry a higher risk because they are private agreements and there is a risk that one party may default on the contract. Futures, being traded on an exchange, have lower counterparty risk as the exchange acts as the intermediary and guarantees the performance of the contract.

Overall, while both forwards and futures serve the same purpose of allowing parties to hedge against price fluctuations, they differ in terms of customization, liquidity, settlement, and counterparty risk.

Compare and Contrast Forwards and Futures

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