Short answer: A forward market is where two parties privately agree today on a price for buying or selling an asset on a later date. These deals are negotiated directly between the two parties rather than on a stock exchange, and their terms can be tailored. Futures serve a similar purpose, but they are standardised contracts traded on an exchange, where the exchange or a clearing house stands behind each trade.
Last reviewed: 3 November 2026
At a glance
| Term | What it means |
|---|---|
| Forward contract | A privately negotiated agreement to buy or sell an asset at a price fixed today, for delivery later |
| Over the counter (OTC) | Traded directly between the two parties, not on a stock exchange |
| Futures contract | A standardised contract traded on an exchange, with uniform maturity and contract size |
| Physical delivery | A forward settled by the actual handover of the asset |
| Cash settlement | A forward settled by a cash payment instead of delivery |
| Non-deliverable forward | A forward that is always cash-settled, based on the gap to a reference rate |
What is a forward contract?
A forward contract is a commitment between two parties. One agrees to buy and the other agrees to sell an asset, at a price fixed on the day the contract is made. The actual exchange happens on a later date, called the settlement date.
The price is locked in at the start. If the market price moves before the settlement date, the buyer still pays the agreed price, and the seller still receives it. Each side gives up the chance to benefit from a move in the other direction.
How do forward contracts trade?
Forwards trade over the counter, which means directly between the two parties. There is no exchange in the middle that lists the contract or sets its terms. Each side deals with the other, and the agreement is only as strong as the other party’s willingness and ability to honour it.
Because the parties negotiate the deal themselves, the size of the contract, its settlement date, its delivery terms and its price can all be customised. A manufacturer who needs 500 tonnes of an input in three months can agree a forward for exactly that quantity and date. A standard exchange contract would not necessarily match those figures.
How are forwards settled?
A forward can be settled in one of two ways. Under physical delivery, the seller hands over the asset and the buyer pays the agreed price. Under cash settlement, no asset changes hands, and only the difference is paid.
Cash settlement is common where delivering the asset is impractical. The parties agree on how the difference will be measured, and the payment is made on the settlement date.
What is a non-deliverable forward?
A non-deliverable forward is a forward that is always cash-settled. At maturity, the payout equals the gap between the agreed rate and the prevailing spot or reference rate. The “spot rate” is the current market price for immediate delivery, and the “reference rate” is the benchmark the two parties agreed to use.
Here is a hypothetical example, with all figures invented for illustration. Suppose two parties agree that the buyer will purchase 1,000 units of an asset at ₹100 per unit, for settlement in six months. At maturity, the reference rate is ₹104 per unit. The seller pays the buyer the gap: 1,000 × (₹104 − ₹100) = ₹4,000. If the reference rate had fallen to ₹97, the buyer would instead pay the seller 1,000 × (₹100 − ₹97) = ₹3,000.
How do futures differ from forwards?
Futures are standardised. The exchange sets the maturity dates and contract sizes, so every futures contract of a given type has the same terms. A buyer or seller cannot change the quantity or the date to suit a particular need.
Futures are also traded on an exchange, not directly between two parties. The exchange or clearing house stands behind each trade and ensures that the obligations are met. This reduces counterparty risk, which is the risk that the other party fails to honour the deal.
The trade-off is flexibility. Forwards can be tailored but carry the risk that the other side will not pay. Futures reduce that risk but cannot be adjusted beyond their standard terms.
Where are the risks in a forward?
The main risk is counterparty risk. Because a forward is a private agreement, its value depends on the other party meeting the obligation on the settlement date. A forward without an exchange or clearing house behind it leaves that risk with the two parties themselves.
The second point to understand is the locked-in price. A forward can work out well or badly, depending on where the market moves. If the price moves against you, you still have to honour the agreed price. A forward is a commitment, not an option to walk away.
Frequently asked questions
Is a forward contract the same as a futures contract?
No. A forward is a privately negotiated, customisable agreement traded over the counter. A futures contract is standardised and traded on an exchange, where the exchange or clearing house stands behind the trade.
Who guarantees a forward contract?
A forward contract is not backed by an exchange or clearing house, since it trades directly between the two parties. The obligations depend on each party meeting its commitment on the settlement date.
What is the difference between physical delivery and cash settlement?
Physical delivery means the asset itself is handed over in exchange for the agreed price. Cash settlement means no asset is delivered, and only a cash payment is made for the gap between the agreed and prevailing prices.
Can a non-deliverable forward involve delivering an asset?
No. A non-deliverable forward is always cash-settled, with the payout equal to the gap between the agreed rate and the spot or reference rate at maturity.
Sources and last check
Facts in this article were checked against the sources below on 3 November 2026. Rules and figures can change; check the primary source before acting.
- upstox.com (broker education)
- kotakneo.com (broker education)
- 5paisa.com (broker education)
- zerodha.com (broker education)
- groww.in (broker education)
This article is general information, not investment advice. MyFinanceBandhu is not a SEBI-registered investment adviser.
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