Deep Dive · Forwards · Lesson 3
Why Use
a Forward?
Big Idea
If futures are more liquid and safer — a clearinghouse guarantees them and daily settlement stops losses from piling up — why do forwards exist at all? Because a forward can be customised: any amount, any date, any asset. That gives it a perfect fit a standardised future simply cannot. The perfect fit, plus privacy and no daily cash flows, is the whole appeal.
- A future gives liquidity and safety — but fixed, standardised terms.
- A forward gives a perfect fit — the exact size, date, and asset you need.
Forwards survive because a perfect fit is sometimes worth more than liquidity.
The Case for Customisation
A future comes in a fixed size and a short list of expiry dates set by the exchange. Your real exposure rarely lines up so neatly — you might owe an odd amount on an odd day. When a standard contract does not match, it leaves an awkward gap: a little too much hedge or a little too little, settling on the wrong day.
A forward is written to fit. Because it is a private, negotiated deal, every term bends to your exposure instead of forcing your exposure to bend to the contract. That is the single reason businesses reach for forwards.
Any Size, Any Date, Any Asset
The flexibility runs along three dimensions. A forward can be shaped on all three at once.
| Dimension | What a Forward Allows |
|---|---|
| Size | Any exact quantity — not a fixed contract size |
| Date | Any settlement day — not just the listed expiries |
| Asset | Even things no exchange lists — an exotic currency, a specific grade or location of a commodity, a bespoke rate |
Any size, any date, any asset — the terms are whatever the two parties agree.
A Perfect Hedge vs a Rough One
Suppose a company needs to hedge exactly €1,350,000. Currency futures come in a fixed size — say €125,000 per contract — so the company can only trade a whole number of them. It can get close, but never exact, and it must accept a listed expiry date rather than the day its exposure actually falls due.
| Choice | Amount Hedged | Result |
|---|---|---|
| 10 futures | €1,250,000 | Under-hedged by €100,000 |
| 11 futures | €1,375,000 | Over-hedged by €25,000 |
| 1 forward | €1,350,000 | Exact — on the exact date needed |
With futures the company is stuck: 10 contracts leave part of the exposure unhedged, 11 overshoot, and neither settles on the right day. Those mismatches leave a small residual — basis — risk. A forward is written for exactly €1,350,000 on exactly the date needed, so nothing is left over. That is a perfect hedge against a rough one.
Privacy and Simplicity
Forwards are private. There is no public position on an exchange, so a large or sensitive deal stays out of view — useful when a visible trade might move the market or reveal a company’s hand.
They are also operationally simpler. A forward has no daily settlement — no margin calls, no daily cash to manage — so a business is not moving money in and out every day. The catch is that the risk builds silently until maturity, where the whole contract settles at once.
The Tradeoffs You Accept
None of this is free. In return for the perfect fit you take on the two hazards from Lesson 2: counterparty risk, because no clearinghouse stands behind the deal and you depend on the other side to perform, and illiquidity, because there is no exchange to sell back into — a forward is hard to exit early.
A forward is the right tool when the fit matters more than the ability to get out.
Interactive Checks
Check 1 of 3
Futures are more liquid and cleared by a clearinghouse.
Why do forwards still exist?
Check 2 of 3
A company must hedge exactly EUR 1,350,000 on a specific date. A standard currency future comes in EUR 125,000 units.
Which fits better?
Check 3 of 3
A forward gives you a perfect fit that a standardised future cannot.
In exchange for that fit, what do you accept?
Common Beginner Mistakes
- ❌ Thinking forwards are obsolete now that futures exist. Forwards survive precisely because they do something futures cannot — fit an exposure exactly.
- ❌ Assuming a standardised future can always match your exposure. Fixed sizes and listed dates rarely line up with an odd amount on an odd day.
- ❌ Forgetting the tradeoffs. A perfect fit comes with counterparty risk and illiquidity — they do not disappear.
- ❌ Using a forward when you will likely need to exit early. Forwards are hard to unwind; if flexibility to get out matters, a future is better.
Quick Memory Tool
- Forwards exist for one reason: customisation
- Any size, any date, any asset
- A forward gives a perfect fit; a future gives a rough one
- Forwards are private and need no daily cash
- The price of that fit is counterparty risk and illiquidity
Next Lesson
Currency Forwards — the most common forward of all. Next we see how a business locks in an exchange rate today for a payment or receipt due in the future.