| Forward | Futures |
|---|---|
| Not standardized. They offer flexibility in terms of maturity date and contract amount, but they lack liquidity because there is no standard format. | Standardized. They are for standard amounts and for standard maturity dates, usually the third Wednesdays of March, June, September and December, thus offer greater liquidity. |
| They are over-the-counter arrangements between bank and customers. | They are traded in organised exchanges. |
| Lack liquidity | Greater liquidity |
| The most important difference is the time pattern of the cash flows between parties to the transaction. In a forward contract, whether it involves full delivery of the two currencies or just compensation of the net value, the transfer of funds takes place once: on maturity. | Cash changes hands every day during the life of the contract, or at least every day that has seen a change in the price of the contract. This daily cash compensation feature largely eliminates default risk. The lower default risk allows the exchange to enter into contracts with companies and individuals who do not have “impeccable” credit rating. |
The standardisation described above may limit the usefulness of future contacts for hedging but is essential for market liquidity. Furthermore, limited size and maturity dates do not necessarily prevent the use of future contracts for hedging because if for example a company wants to hedge a non-standard amount for a date that does not coincide exactly with that of a future contract, it could enter into a number of contracts with a later maturity date and liquidate the contracts on the date required.
