A forward market, unlike the stock, derivatives, or commodity markets is not an exchange, but an over-the counter (OTC) marketplace that trades foreign currency, securities, interest rate, and commodities. The term forward market is often used to refer to the forex market.
This is where forward contracts can be bought and sold to protect investments or speculate (maximizing returns). The Forward Markets Commission regulates both future and forward markets in India.
We gave you an overview of the forward market. Below, we will explain how forward contracts are used in the forward market.
A forward contract is a contract between two parties that allows them to purchase or sell an asset at a fixed price in the future. Contrary to options and futures contracts, a forward contract requires both parties to the transaction to complete the transaction.
Optional or future contracts allow buyers and sellers to sell their contract prior to the expiration date and close their position. Both parties are required to deliver the underlying asset in a forward contract, regardless of whether it is currency, commodity, or other securities. Understanding what a forward contract means will help you to understand what the forward market is.
It is important to identify the participants in a forward-market to be able to understand the workings of a forward contract and its meaning. Hedgers use forward contracts to offset losses, and speculators use them to make money from price fluctuations.
To protect themselves against losses, hedgers use forward markets to hedge their risks if the market price goes against them. However, speculators do not want to own the commodity or currency and instead place bets on the direction of price. Hedgers tend to use forward contracts more than speculators.
Let's look at a simple example to show how it works:
Imagine that you are a farmer and plan to harvest 10 tonnes of wheat next year. The wheat must be sold at Rs. To make a profit, you must sell the wheat at Rs. 5,000 per tonne. There are two choices: Either you can do nothing and hope your produce sells for Rs. You can either sell it for Rs. 5,000 or lock in future prices.
You can enter into a forward agreement with a flour mill owner, or a flour marketing firm to sell wheat at Rs. After harvest, the price per ton is Rs. 5,000 This will protect you from any possible decline in wheat prices. The flour mill owner could also sign a contract to lock the prices, so that he doesn't have to buy more wheat after harvest.
The forward market is an important part of the Indian economy. It provides price support and protection to key sectors. Forward contracts that are executed via the forward market can be understood by anyone with no trading experience. Participants can trade in a variety of commodities such as natural gas and oil, beef, electricity or orange juice.
For those who are new to trading and investing, it is easy to get confused between the futures and forward markets. This is how to distinguish the two.
Forward Market and Futures Market
|Futures Market||Forward Market|
Types of contracts
Deals In Future Contracts
Deals In Forward Contracts
The Size of Contracts
Predetermined Standardized Sizes or Lots
The size of contracts is determined by the needs and not standardized.
There are risks
Margin Amount and Exchange Regulation can reduce risk. Moderate risk
Participants are not required to deposit a margin amount and there is no exchange to regulate transactions. High risk of default
Delivery for Settlement
Transactions Below 2%
More than 90%
The forward market is by definition not a centralised exchange. Retail investors are limited in their access to it. The majority of transactions are done by cash or delivery. They are more aligned for those who directly trade or produce the underlying assets.