Page 250 - A Canuck's Guide to Financial Literacy 2020

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Forward Contracts

A forward contract is a contract between two parties who agree to buy or sell an underlying
asset at a specific price sometimes in the future. These types of contracts are often used by
multinational corporations to hedge against risks or speculate on the underlying asset. Keep
in mind that forward contracts are not the same as futures contracts, particularly due to the
lack of centralized trading.

Types of Underlying Assets

As mentioned, a forward contract is between who parties to agree to buy or sell an
underlying asset in the future. The actual exchange of cash or assets take places at a future
time but the price is determined upon contract agreement. These underlying assets typically
fall into two main categories: financial & commodities.

Financial - Financial forward contracts involve the trading of financial instruments such as
currencies, interest rates, shares and other securities. The most common financial forwards
are currencies and interest rates.

Commodities - Commodities include natural gas, silver, gold, copper, oil, electricity, wheat,
sugar, etc. The commodity market is less centralized than the financial market.

One unique aspect of commodity forward contracts is that they're customizable and offer
flexibility on the commodity type, delivery date and amount. For example, a farmer can sell
their crops before the seeds are planted, if he believes that prices would decline in the
future. Commodity forwards can be settled in cash or through the actual delivery of the
commodity.