"Future" vs. "Forward"

[Jovial Guan]

Hi all,
I am not sure about the difference between "future" and "forward". Can anybody here explain more on these two terms?

[Actuarybert]

Economically, a future and a forward are basically the same type of transaction--both involve an agreement to buy or sell an asset at a fixed price on some future date. The main differences are:

(1) Forward contracts are generally customized; futures contracts are standardized (i.e. with respect to maturity, size, and the underlying assets)
(2) Forward contracts are sold over the counter; futures are traded on exchanges
(3) Futures are more liquid than forwards
(4) Futures contracts are settled on a daily basis; forward contracts aren't settled until maturity. Example: Suppose you take a long position in a futures contract. On the first day, the value of the underlying asset increases by $50, so the person with the short position would pay you $50. On the second day, the price of the asset decreases by $20, so you have to pay $20 to the person with the short position. If this had been a forward (rather than a future), you would wait until the maturity date to settle up. So, in this example, (assuming that the forward contract matures on the second day), you would wait until the maturity date to settle up, and the person with the short position would just pay you the net change ($50 - $20 = $30) in the price of the underlying asset.

Hope this helps.

[zapped]

i agree with AB's response. i would like to add:

(5) forwards have counterparty risk, futures are backed by the exchange.
(6) the only performance guarantees that forwards have is the credit worthiness of the other company. futures require that the investors in short and long positions post a margin of good faith.
(7) as for transaction costs, forwards have bid/asked spreads. futures have fees & commissions.

[Tim Hortons]

(7) as for transaction costs, forwards have bid/asked spreads. futures have fees & commissions.

If futures are traded on Exchanges, couldn't there be a bid/asked spread with the specialist?

[toomuchtime]

There probably are specialist bid-ask spreads, but the fees/commissions are more important to the investor, as that is the only cost they will "see". Plus, the textbook doesn't mention it...

[ACCtuary]

Most futures exchanges, in the US, anyway, are done in essence, by open-outcry auction. The trader announces he wants to buy (or sell) and will then buy from the lowest (highest) offer he gets. There is no bid/asked spread and no specialist.

The Chicago Board of Trade (http://www.cbot.com/) is one example. They have some interesting and useful information there, such as how the jacket color system works and other arcana, but don't be memorizing that . :roll:

[slam]

There probably are specialist bid-ask spreads, but the fees/commissions are more important to the investor, as that is the only cost they will "see". Plus, the textbook doesn't mention it...


When studying for C6 2 years ago, this particular point annoyed me a lot. The book is wrong. There ARE bid/ask spreads on the floor in addition to the fees and commissions. When you buy or sell a future you pay a commission to your broker (the guy you're talking to directly), a fee to a clearing house and the CFTC, and a bid/ask spread to the trader on the floor who takes the opposite side of your trade. From largest to smallest, these three usually rank 1)bid/ask 2)commission 3)fee. Sometimes you get lucky and the other side of your trade is taken by someone who wants the position rather than someone who is willing to take the position in exchange for a little extra money, and then the bid/ask might be the smallest.

In the case of an over-the-counter (not on the floor) trade, these three fees are generally combined into bid/ask spread and all you see is a final price. Depending which market you're trading in, you might explicity see the bid/ask spread or you might be quoted just the side of market your interested in.

[slam]

Most futures exchanges, in the US, anyway, are done in essence, by open-outcry auction. The trader announces he wants to buy (or sell) and will then buy from the lowest (highest) offer he gets. There is no bid/asked spread and no specialist.

The Chicago Board of Trade (http://www.cbot.com/) is one example. They have some interesting and useful information there, such as how the jacket color system works and other arcana, but don't be memorizing that . :roll:

Don't confuse open-outcry with no bid/ask spread. There still is a bid/ask spread, it's just that the bid and the ask may be by different people. A lot of people make tidy livings by the existence of the bid/ask spread.

[ACCtuary]

Don't confuse trading profit with bid/asked spread. The definition of bid/asked spread is that it is indeed one specific person (presumably with carrying costs for holding an inventory of a security) who is making it.

Not that there isn't slippage and market execution issues, but this takes us beyond the scope of the exam.

[slam]

I disagree. A bid/ask spread is that of the market, not necessarily of any individual. An individual trader typically has his/her own bid/ask spread which may or may not agree with the market's.

[zapped]

for over the counter markets (i.e., Nasdaq), dealers enter their own bid/asked prices & make markets in doing so. this is a case where individuals & markets have the same bid/asked spread. i can't think of any other case where there is a "market" b/a price or spread.

[slam]

Every market has a bid/spread. The market's bid is the best bid of any market participant and the market's ask is the best offer of any participant. In the NASDAQ example, Dealer A may be 5.5 bid, at 6. Dealer B may be 5.75 bid, at 6.25. The market is 5.75 bid, at 6. Also, there are other markets which operate similarly to the NASDAQ in the manner which was described above. Foreign exchange, for example. Other markets establish their bid/ask's in different ways, but they all establish a bid/ask. It's the nature of a market.

[zapped]

i don't see how you can use the NASDAQ as a place to quote the "market" b/a price since it is made up of many dealers who make their own markets- the NASDAQ is not a formal trading system, and people don't converge at one place as in an exchange.

if there was a "market" b/a price it would be quoted as such. but brokers must search the NASDAQ for the best b/a quotes. so i don't see the "market" b/a price / spread in that case. maybe on an exchange there is one.

but the NASDAQ is merely a subscription computer system where dealers go to make markets by entering their own b/a prices, brokers go to find deals for clients (receive all b/a prices), and investors go to get information (receive median b/a prices, not "market" b/a prices).....

[slam]

The combination of all those individual bid/ask spreads IS the market. From them, the market implies its bid/ask spread, whether it is quoted explicitly that way, or not.

[zapped]

whatever dude.