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Glossary

Forward Contract

Financial Term

A forward contract is a type of financial contract between two parties that agrees to buy or sell an asset or commodity at a predetermined price and time in the future. The contract is not traded on the open market and is customized to meet the specific needs of the parties involved.

These contracts are often used in the financial industry as a way to manage future price risk. For example, a farmer may enter into a forward contract with a food processing company to sell their crop at a set price before the harvest. This helps the farmer to lock in a price for their crop and eliminates the risk of price fluctuations in the market. Similarly, a manufacturing company may use a forward contract to buy raw materials at a set price ahead of time to ensure that they have adequate supplies on hand and to avoid price volatility.

Forward contracts are also commonly used by currency traders as a way to manage foreign exchange risk. Banks and other financial institutions trade forward contracts as a way to manage the risk associated with fluctuations in foreign exchange rates. This allows companies to protect themselves against currency fluctuations and reduces their exposure to potential losses.

Overall, forward contracts provide a way for investors to manage their exposure to price risk, whether in commodities, foreign exchange, or other assets. By doing so, they can better predict future cash flows and ensure that their investment portfolios are properly diversified.


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