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A currency futures market is an exchange-traded contract that sets the price of one currency at which another currency will be sold or bought in the future. A currency forward market is a marketplace that sets up the exchange rate for buying and selling the currency or other assets on a determined future date.
Both the contracts seem similar to each other, as they certainly have fundamental functions and nature. However, they have significant differences. The foremost difference between both markets is that futures are traded publicly on exchanges while forwards are traded privately.
If you’re still unsure of the difference between the two markets, we’ve properly mentioned the major differences between the forward currency market and the futures market.
Let’s start the comparison !!
What is the currency future market?
Currency futures, also known as forex futures, refer to the exchange-traded contracts that specify the price of one currency at which another currency will be purchased or sold on a future date.
Participants in the future market consist of banks, mutual funds, etcetera. Moreover, the contract helps predict currency price swings and hedges other trades and currency risks, including exchange rate swings.
For instance, the euro and the dollar (EUR/USD) are a fine example of a currency pair with an exchange rate. These are properly regulated, and any counterparty holding the contract at the expiration date is legally required to take delivery of the currency at a given date and price.
Futures seem similar to the currency forward but are standardized and traded in centralized exchange instead of customized.
What is the currency forward market?
The Currency forward market refers to an over the counter foreign exchange market place that helps you define the exchange rate for buying and selling of currency and other assets on a specified future date.
It is a customizable hedging tool that doesn’t involve an upfront margin payment. The forward currency market is usually opted for by large financial institutions, banks, and industries.
Moreover, the currency forward doesn’t come up with standardized terms and can easily be customized to a particular amount for any maturity or delivery period, unlike exchange trade currency futures. In simple words, buyers and sellers can alter the contract’s terms and settlement procedure without consulting any third party.
Quick comparison between currency future market vs. currency forward market
Here’s the required comparison between the currency future and forward market in the currency future and option market:
| Category | Forward Contract | Future Contract |
| Meaning | It is a private contract between two parties to buy or sell an asset. | It is a standardized agreement to buy or sell an asset at a defined price on a specified date. |
| Contract Type | Customized contract | Standardized contract |
| Contract Size | Small | Large |
| Underlying Requirement | None | It requires open currency position |
| Liquidity and Transparency | It lacks transparency and liquidity; private agreement | Highly liquid and traded on exchanges; providing transparency |
| Regulations | It has minimal to no regulations | Exchanges and Relevant Authorities regulate it properly |
| Risk | Higher counterparty risk | Lower counterparty risk |
| Settlement | These contracts are settled in cash at the maturity date | These contracts are settled daily in cash as the difference between the spot price and future price |
| Margin | No collateral is required, as both parties trust each other to honour the contract | A collateral is required here, as the initial margin and maintenance margin have to be deposited and maintained, respectively |
| Costs | Generally have lower transaction costs | It may include brokerage, margin requirements, and exchange fees |
| Price Determination | Prices are mutually agreed here between both the parties involved | Prices are determined by open market forces here |
| Expiry of the Contract | Depends on the contract | Standard |
Currency future market and the forward market
Listed below are some of the major differences in the currency futures market and the forward market.
1. Counterparty Risk
The Futures market is an exchange-traded market structured by the exchanges and guaranteed by the clearing business. Simply put, there is no counterparty risk, as it is a guaranteed market. The clearing organization guarantees every deal takes place here.
The Forward market is an OTC (over-the-counter) market. The technical counterparty risk is involved here. Giant banks and organizations involved in this market make the risk more hypothetical than actual.
2. Transaction Method
The Futures Market is properly regulated by the frameworks or rules outlined by the governmental bodies. Hence, transaction methods for contracts are managed by the stock exchanges here.
The Forward Market is between the buyer and seller without any interference of government authorized intermediary. Here, transaction methods for contracts are managed, executed, and negotiated by both the participants involved.
3. Pricing
The Futures market has an effective price discovery mechanism due to its centralized frameworks outlined and managed directly by the government. Here, the pricing is more transparent, as determined by the government body.
The Forward market generally has an inefficient price discovery mechanism that doesn’t demonstrate enough transparency. However, the prices are less transparent, as dictated and agreed upon by both parties mutually.
Conclusion
The futures and forward markets of currency seem very similar in function. The main difference between both is that futures are handled by the stock exchange, while forwards are operated based upon the mutual contract between two parties.
Now, when you properly understand the difference between both, you can apply the required techniques and strategies for speculation in the futures of forward-market currency and options markets. We hope this article helps you understand the difference. To learn more, subscribe to Stockgro!
FAQs
The FX spot (sport rate) showcases the current exchange rate, and the FX forward (forward rate) is the predetermined rate for future transactions.
The future contract has a government-authorized intermediary (stock exchange) between two parties, while the forward contract consists of a signed agreement between two parties face to face.
Currency forwards (FX forwards) can help you hedge other positions. Here, you have to open a contract to offset risk to an existing trade, including an open spot forex position.
The Spot rate is used when the agreed trade takes place today or tomorrow. In contrast, the forward rate is used when the agreed trade is not decided to occur until later in the future.
FX forwards refer merely to the function of relevant interest rates. The duration of the contract doesn’t reflect any expectation regarding where the price is headed.