A forward market is an over-the-counter (OTC) marketplace for foreign exchanges, securities, interest rates, and commodities, unlike the stock, derivatives, or commodity markets. The term forward market is most commonly associated with the currency market.
It's a market where forward contracts are bought and sold for hedging (investment protection) or speculation (maximizing returns). The Forward Markets Commission regulates both forward and futures markets in India.
Forward Market Meaning
The forward market is the marketplace that sets the price of assets and financial instruments (Bonds, Swaps, Equity, Cap, Futures, Forward rate agreements, Bills of exchange, and so on) for future delivery and is used for financial instrument trading. In other words, the forward market is the market where we can sell and buy financial instruments and assets for future delivery.
The forward market is the market that is used to determine the price of forward contracts, financial instruments, and assets, as well as to sell and buy them. The trading of instruments takes place on such a market. The forward market allows contract parties to customize the time, amount, and rate at which the contract is to be performed.
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How Does the Forward Market Work?
Forward contracts are created through forward markets. The forward contracts are designed to be used for both speculative and hedging purposes. Forward contracts are exchanged among banks and from banks to their clients.
Forward and futures contracts are accessible in the forward market. Forward contracts could be customized to the requirements of the holder - whereas futures contracts are more standard and uniform in terms of maturity and order size.
Types of Forward Market
The table below talks about the different kinds of classifications of forward markets:
1) Flexible Forward: | The parties might tend to exchange money that is normally on or even before the maturity date using this strategy. |
2) Closed Outright Forward: | The exchange rate is agreed upon between the two parties as to the prevailing spot rate plus the premium in this form of transaction. |
3) Non-Deliverable Forward: | There is no physical delivery with this approach, and the parties agree to merely settle the difference between the spot rate and the exchange rate. |
4) Long Dated Forward: | They are comparable to short-dated contracts, but the maturities are normally for a longer period of time. |
Forward Market Example
Consider the case of a farmer who harvests a particular crop but is uncertain about its pricing three months later. In this situation, the farmer can lock in the price at which he will sell his produce in the next three months by entering into a forward contract with a third party. The forward market is the name given to the market for such a transaction.
Benefits of the Forward Market
There are various advantages of using the forward market:
- In the forward market, parties enter and decide the quantity, time, and rate at the time of delivery according to their own needs, requirements, and specifications. It is extremely adaptable and practical for both parties.
- It is extremely beneficial to parties who have specific commodities that they will need to exchange in the future. The forward market provides a complete hedge and attempts to eliminate various risks so that parties can protect their commitments.
- The products in the forward market are usually traded over the counter. Rather than engaging in future contracts, the majority of institutional investors prefer to deal with them. Over-the-counter goods provide them the freedom to customize the duration, contract size, and approach to meet their specific needs.
- The parties can now match their exposure to the period in which they can enter the contract. They may adapt it to fit any party and change the time based on this.
Difference Between Forward Market and Futures Market
People who are new to investing and trading frequently misunderstand the forward and futures markets. Here's a quick technique to tell the difference between the two.
Forward Market | Futures Market |
This market deals with forward contracts only. | This market deals only with futures contracts. |
It is a self-regulated market. | It is a market that is regulated by SEBI. |
The contracts of this market are tailored based on needs, and they are not standardized. | The contracts of this market are standardized on predetermined sizes and lots. |
The major risk of this market is that the participants are not needed to deposit a margin amount, and there is no exchange that can regulate transactions. | The risks of this market are moderate as they are minimized by margin amount and exchange regulation. |
The settlement by delivery in this market is more than 90%. | The settlement by delivery here is less than 2% of the transactions. |
