What Is a Forward Market

The forward market is the marketplace that sets the price of assets and financial instruments (Bonds, Swaps, Equity, Cap, Futures, Forward rate agreements, Bills of exchange, and so on) for future delivery and is used for financial instrument trading. In other words, the forward market is the market where we can sell and buy financial instruments and assets for future delivery.

The forward market is the market that is used to determine the price of forward contracts, financial instruments, and assets, as well as to sell and buy them. The trading of instruments takes place on such a market. The forward market allows contract parties to customize the time, amount, and rate at which the contract is to be performed.

Read about: What is OTC Options

How Does the Forward Market Work?

Forward contracts are created through forward markets. The forward contracts are designed to be used for both speculative and hedging purposes. Forward contracts are exchanged among banks and from banks to their clients.

Forward and futures contracts are accessible in the forward market. Forward contracts could be customized to the requirements of the holder - whereas futures contracts are more standard and uniform in terms of maturity and order size.

Types of Forward Market

The table below talks about the different kinds of classifications of forward markets:

What are Non-Deliverable Forwards? 

NDFs or non-deliverable forwards are unique financial contracts allowing parties to hedge against/speculate on future currency exchange rates. However, this is done without any physical exchange of the underlying currencies. These agreements are mostly seen in emerging markets where there is limited direct access to onshore currency markets, or where currencies are not as freely convertible. 

Here are some key aspects of NDFs: 

• NDFs are cash-settled. This means that the difference between the NDF price that is agreed upon and the prevailing spot rate will be paid in cash at the time of maturity. 
• There is no physical delivery of the currencies at the time of maturity unlike regular forward contracts. 
• These are usually OTC (over-the-counter) trades negotiated privately between two parties. They also have a certain amount of counterparty risk, i.e. the risk of any one party defaulting on the contract. 
• An investor/trader may use the NDF to speculate on a currency’s future value, hoping to notch up profits from any such changes in exchange rates. 
• Companies with operations in restricted currencies may use NDFs for hedging against any future losses arising from currency fluctuations. 

Forward Market Example

Consider the case of a farmer who harvests a particular crop but is uncertain about its pricing three months later. In this situation, the farmer can lock in the price at which he will sell his produce in the next three months by entering into a forward contract with a third party. The forward market is the name given to the market for such a transaction.

Benefits of the Forward Market

There are various advantages of using the forward market:

• In the forward market, parties enter and decide the quantity, time, and rate at the time of delivery according to their own needs, requirements, and specifications. It is extremely adaptable and practical for both parties.
• It is extremely beneficial to parties who have specific commodities that they will need to exchange in the future. The forward market provides a complete hedge and attempts to eliminate various risks so that parties can protect their commitments.
• The products in the forward market are usually traded over the counter. Rather than engaging in future contracts, the majority of institutional investors prefer to deal with them. Over-the-counter goods provide them the freedom to customize the duration, contract size, and approach to meet their specific needs.
• The parties can now match their exposure to the period in which they can enter the contract. They may adapt it to fit any party and change the time based on this.

Difference Between Forward Market and Futures Market

People who are new to investing and trading frequently misunderstand the forward and futures markets. Here's a quick technique to tell the difference between the two.

Forex Forwards

Forex forwards are OTC (over-the-counter) derivative contracts enabling two parties to exchange currencies for a particular exchange rate and at a future date. The rate is fixed at the time of undertaking the contract and the actual exchange takes place on the future date that is agreed upon by both parties. . 

Some key aspects of Forex Forwards include: 

• These are legally binding contracts where both parties are obligated to adhere to their commitments. 
• The exchange rate is fixed at the time of entering into the contract, enabling certainty for future conversion of currency. 
• Traders/businesses can hedge against future exchange rate fluctuations through these contracts. 
• They are usually privately traded between financial institutions and businesses instead of public exchanges. 
• Companies importing goods from other countries may potentially use Forex forwards to lock-in exchange rates for future payments. This helps safeguard them from future losses on account of exchange rate fluctuations. 
• Forex forwards may also be used for speculating on future exchange rate movements. Traders/businesses may bet on whether any particular currency will weaken/strengthen in the future. 
• These contracts may also help firms manage cash flows better, since they know the exact amount they will require to make payments in foreign currencies.