What are the key differences between forward and futures contracts?
I'm studying derivatives for CFA Level I and both forwards and futures seem to do the same thing — lock in a price for future delivery. But the textbook lists several differences. Can someone clearly outline when you'd use one vs. the other?
You're right that both forwards and futures obligate two parties to transact at a predetermined price on a future date. But the structural differences are significant and heavily tested on the CFA exam.
Side-by-side comparison:
| Feature | Forward | Futures |
|---|---|---|
| Trading venue | OTC (private) | Exchange |
| Standardization | Fully customizable | Standardized contracts |
| Counterparty risk | Yes (bilateral) | Minimal (clearinghouse) |
| Settlement | At expiration only | Daily mark-to-market (margin) |
| Liquidity | Generally less liquid | Highly liquid |
| Regulation | Less regulated | Heavily regulated |
| Margin requirement | None (or negotiated collateral) | Initial + maintenance margin |
| Typical users | Corporations hedging specific exposures | Speculators + hedgers |
Daily mark-to-market explained:
With futures, gains and losses are settled every day through the margin account. If you're long a crude oil future at $75 and the settlement price moves to $73, you lose $2 per unit that day — and must deposit cash if your margin falls below the maintenance level. This eliminates the buildup of large unrealized losses.
Example: Apex Manufacturing needs to buy 50,000 pounds of copper in exactly 47 days. A futures contract might be for 25,000 pounds with monthly expirations — not a perfect match. A forward contract can be tailored to exactly 50,000 pounds, delivered in 47 days, at a negotiated price. Apex accepts the counterparty risk in exchange for the perfect hedge.
Exam tip: The CFA exam loves asking about which feature reduces credit risk (answer: daily settlement/margin). Also remember that forward and futures prices can differ when interest rates are correlated with the underlying — this is covered at Level II.
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