Next, let us discuss the concept of the 'Futures' contract and how it differs from Forwards.
What is a futures contract?
A future contract is similar to the forward contract in terms of its basics; however, the key difference is that a future contract is standardized in nature and is traded on stock exchanges. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract.
So, futures can be summarised as -
- A standardized contract with standard underlying instrument,
- A standard quantity and quality of the underlying instrument that can be delivered,
- A standard timing of such settlement
The futures market came into existence overcoming the shortcomings of the forward market. Futures market is more pronounced among the trader and investor community across the world because of the fact that the counterparty or the default risk is virtually zero. Every futures contract carries a guarantee from the exchange where it is traded and hence in case of any default by the counterparty, it becomes the obligation of the exchange to pay off the other party.