Differentiate between forwards and futures contracts.

Differentiate between forwards and futures contracts.

• A. Forwards are standardized, exchange-traded with daily settlement; futures are private, customizable OTC.
• B. Forwards are private, customizable OTC agreements; futures are standardized, exchange-traded with daily settlement.
• C. Forwards require daily settlement; futures do not.
• D. Forwards and futures are identical in contract terms.

Answer: (B)

Forward contracts are private, customizable OTC agreements between two parties, settled at maturity and exposed to counterparty risk because there’s no central clearing. Futures contracts, on the other hand, are standardized in quantity and delivery terms, traded on an exchange, and settled daily through a mark-to-market process with margin requirements. This daily settlement reduces credit risk and provides higher liquidity, since positions can be more easily offset in a centralized market. The combination of customization and private trading characterizes forwards, while standardization, exchange-trading, and daily settlement characterize futures.

Forward contracts are private, customizable OTC agreements between two parties, settled at maturity and exposed to counterparty risk because there’s no central clearing. Futures contracts, on the other hand, are standardized in quantity and delivery terms, traded on an exchange, and settled daily through a mark-to-market process with margin requirements. This daily settlement reduces credit risk and provides higher liquidity, since positions can be more easily offset in a centralized market. The combination of customization and private trading characterizes forwards, while standardization, exchange-trading, and daily settlement characterize futures.