Page 252 - A Canuck's Guide to Financial Literacy 2020

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In regards to settlement, future contracts settle everyday, making them highly liquid in
comparison to forward contracts that settle upon maturity. The parties to a forward contract
bear more risk considering that there is no clearinghouse that guarantees performance and
completion of the contract. If a party to a forward contract were to default, they may be
liable to lawsuits by the other party.

Valuing Forward Contracts

The value of a forward contract is linked to the underlying asset. Referring to our example
above, if Dempster's Bread Company is required to pay $2000 for 500 bushels of wheat but
the market price drops to $1400 for 500 bushels of wheat, the contract would be worth $600
to the seller as they would get $600 more for their goods. Forward contracts are a zero-sum
game, meaning there are no two winners.

The bottom line is that forward contracts are widely used by investment professionals to
hedge and speculate. Those who purchase forward contracts to hedge are not seeking to
generate a profit but rather minimize their risks. Speculators on the either hand are placing
bets on the direction of the underlying asset. They're unlikely to take possession of the
underlying asset. The majority of forward contracts are used by hedgers rather than
speculators.