A forward contract is a privately negotiated, OTC agreement between two counterparties to buy or sell an asset at a specified forward price on a specified future date. Unlike futures, forwards are not standardized — contract terms (size, date, settlement method) are customized to the parties' needs — and they do not trade on exchanges. There is no daily mark-to-market; the contract is settled at maturity (physical delivery or cash settlement).
Because forwards are OTC and not exchange-cleared, they carry counterparty (credit) risk — the risk that the other party defaults before settlement. This is the primary disadvantage compared to exchange-traded futures, which have the clearinghouse guarantee. However, the customization flexibility is a major advantage for hedgers needing precise contract terms.
Common uses of forwards: currency forwards (corporations hedging foreign exchange exposure on international transactions), commodity forwards (producers locking in sale prices), and forward rate agreements (FRAs) (interest rate forwards used by banks to lock in borrowing rates).
Forward price is determined by the cost-of-carry model: Forward Price = Spot Price × (1 + risk-free rate)^t − carrying benefits (dividends, convenience yield) + carrying costs (storage). In efficient markets, the forward price represents the market's unbiased estimate of the expected future spot price.
> Exam tip: On the Series 65/66 and CFP, compare forwards to futures: forwards are customized, OTC, bilaterally settled at maturity with counterparty risk; futures are standardized, exchange-traded, daily mark-to-market, with clearinghouse guarantee. Both obligate both parties (unlike options). Forward contracts are not securities and are primarily used in institutional hedging contexts.