Forex Future Contract - Definition And Features

                                                                               

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What is a Forex Future Contract?

A Forex Future Contract also known as FX future is a contract to exchange one currency for another in future at a specified date and at an exchange rate prevailing on that specified future date.

A Forex Future Contract is an agreement between two parties to exchange a certain amount of currency against another at a fixed exchange rate on a fixed future date.

In other words, an FX forward contract is an agreement to buy or sell a specified amount of a foreign currency at a specified price for settlement at a predetermined time in the future.

With the help of this type of contract both the parties are able to effectively lock-in the exchange rate for a future transaction.

Forward contracts are similar like future contracts except they are not exchange-traded or defined on standardized assets. Future contracts are highly standardized while the terms of each forward contract can be negotiated and fixed privately. 

Future contracts are traded on exchanges which make them standardized contracts. On the other hand forward contracts are private agreements between two parties to buy or sell an asset at a specified price in the future.

With the help of this device(forward exchange contract) an importer or an exporter can enjoy sufficient protection against exchange risks. 

A Banker and a customer or another Banker can also enter into a contract to buy or sell a specified amount of a foreign currency on a specified future date as a predetermined rate of exchange. 

An exporter can enter into an agreement with his banker to sell a specified amount of foreign currency at a specified future date. The Banker also agrees to buy this at a specified rate of exchange. In this way, the exporter is assured of his fair price in the local currency. 

Advantages & Disadvantages of Future Contract

Future contracts involve a lot of advantages and disadvantages. Some of them may be summarized as follows:

Advantages

• Future contracts have very low margin

• Compared to currency forward contracts cost of trading in futures is very low

• Since future contracts are exchange traded so somehow it reduce counter party risk

• Future contracts enjoy high liquidity especially in currencies, indexes and commonly traded commodities

• Future contracts are simple to understand as it is based on the cost-of-carry model in which future prices are always determined by adding the cost-of-carrying to the spot price of the asset.

• Future contracts are devoid of 'time decay'. In options, value of the asset may dwindle affecting profitability of the trader which is absent in future contracts.

  Disadvantages

• Future contracts involve the risk of insistence by brokers to close positions before delivery.

• These are mainly traded on US based exchanges.

• They are mainly speculative in nature and not flexible for accounting purposes.

• They usually involve large amounts and difficult to close partially

• Traded in lots of preset amounts which are unsuitable for accounting purposes

• High leverage may lead to rapid fluctuations in future prices and prices are subject to going up or coming down daily, rapidly and even instantly.