Forward Contracts versus Futures Contracts

Forward and futures contracts share characteristics.
Both allow investors to hedge against currency risk..
Forward contracts differ to futures contracts in that they are over-the-counter (OTC) contracts traded directly between banks and financial institutions. OTC contracts are often tailored to meet the needs of each individual customer. The disadvantage, however, is that forward contracts are often reserved for larger institutions. Institutions that trade forwards are also required to have all the necessary transactional documentation and may be required to motivate why the forward contract was entered into. The buyers and sellers of OTC derivatives are also subject to the risk that the counterparty to the trade may default.

Futures contracts are exchange traded contracts and thus standardised with respect to quantity and value of the underlying, quotation method and date of expiry. Prices for each contract are negotiated between buyers and sellers via the Yield-X electronic order matching platform or automatic trading system (ATS). Currency future brokers input orders which are automatically matched on the basis of time and price priority. Currency futures therefore allow for transparent pricing. Currency futures also equalize the playing field for all investors. The product allows for individuals to access the currency market generally reserved for institutions and allows smaller corporate entities to access favourable rates generally reserved for larger corporates. Currency futures unlike forwards allow investors to take a view on the movement of the underlying exchange rates.

Performance by the counterparties to a futures contract is guaranteed on Yield-X via Safcom (the JSE’s clearing house) for all derivative contracts. Standardised contracts traded on a regulated exchange enable the risk of both parties to be reduced and also increase the liquidity in the secondary trading market. Liquidity refers to the ability of trading participants to get in and out of their positions when they choose to.