What it means
A forward is an agreement between a buyer and seller, not a prediction that the price will rise. The Bank for International Settlements describes a contract for delayed delivery of a specified instrument or commodity at an agreed date and price or yield, and buying forward is the buyer's side of that agreement.
A food company expecting to need grain in six months may buy forward to budget its input cost, and a manufacturer awaiting foreign-currency invoices may make a similar commitment in currency, so the purpose can be reliable planning rather than speculation. The contract specifies the amount, quality or asset, delivery date, price or price-setting method, and settlement terms.
Customisation is a defining feature of many forwards, and loose terms create disputes when both sides think they agreed on different grades or delivery locations. Settlement may involve physical delivery or a cash difference under the written terms, so do not assume that every buyer must take a truckload, nor that every contract can be settled in cash.
Suppose a processor agrees to buy 100 units in three months for $80 each. If the spot price then reaches $95, the agreed purchase price is $15 lower per unit, but if spot falls to $65, the buyer still generally owes $80 and gives up the cheaper market opportunity.
Forwards are generally bilateral and not standardised or traded on organised exchanges, as the BIS glossary notes, whereas a futures contract is more standardised and typically exchange-traded, with clearing and margin arrangements. Each route has different liquidity and performance mechanics.
Counterparty risk is central too: if the seller fails when market prices have risen, the buyer may have to replace the promised goods at a higher price, and credit checks, collateral or guarantees can reduce but not erase that risk. A business can use a forward to hedge one exposure while creating another.
If it locks in a currency amount and the underlying overseas order is cancelled, it may be left with an unwanted currency commitment, so match the hedge size and maturity to a realistic obligation. The useful question is which uncertainty the buyer is willing to trade.
Buying forward exchanges an unknown future purchase price for a known obligation and counterparty exposure. A sound decision starts with the real asset need, the contract's exit terms and a downside scenario.
In practice
Real-world examples.
Example
A bakery contracts today to buy wheat in October at an agreed price. Rising October spot prices make the contracted purchase look favourable; falling prices leave the bakery paying more than the spot buyer.
Example
An importer schedules a future payment in euros and buys the currency forward to reduce the uncertainty in its local-currency budget. If the invoice is cancelled, the hedge may need to be unwound, possibly at a gain or a loss.
Example
A buyer specifies 100 tonnes of a particular grade for delivery to a named warehouse. The quality and location terms matter as much as the headline price when the goods arrive, because a lower grade or a different delivery point can turn a good price into a dispute.
Formula
Calculation
Illustrative difference versus future spot = quantity x (future spot price - agreed forward price). For 100 units agreed at $80 and a later spot of $95, the difference is 100 x ($95 - $80) = $1,500 in the buyer's favour relative to buying then. If spot is $65, the difference is 100 x ($65 - $80) = -$1,500. This comparison omits fees, basis, credit and any underlying business margin.
Put another way, the buyer's locked cost is 100 x $80 = $8,000 in both cases, while buying at spot would have cost $9,500 in the first case and $6,500 in the second. The forward therefore saved $1,500 in one outcome and cost $1,500 in the other, which is the trade the buyer accepted in exchange for certainty.Case study
Seen in the real world.
Fictional example: Mariam's furniture factory expected to import timber in four months. A supplier offered a fixed forward purchase for the required grade and quantity. Mariam modelled both a price increase and a decrease rather than assuming the lower quote guaranteed profit. She limited the committed volume to confirmed production orders and documented a backup supplier.
Timber prices later fell, so the contract did not beat spot buying. The factory still delivered at the margin it had budgeted, and the smaller contract avoided excess stock when one customer delayed an order. Suppose, hypothetically, that the contract price was $400 per cubic metre, spot fell to $360, and 150 cubic metres were committed. The contract then cost 150 x ($400 - $360) = $6,000 more than spot, a sum Mariam had already built into her budget as the price of certainty.
Watch out
Common mistakes.
- Assuming a forward purchase locks in a profit rather than a price that may be above the eventual market.
- Leaving the asset grade, settlement method or delivery point vague and focusing only on the quoted rate.
- Buying more than the real future requirement and ignoring the cost of an offset or cancelled order.
Questions
People also ask.
Why would a buyer use a forward?
It can make a future purchase price more predictable, especially when the buyer needs an input or currency on a known date.
Is buying forward the same as buying futures?
No. A forward is generally a customisable bilateral contract; futures are standardised and typically traded through an exchange and clearing system.
What if the market price falls?
The buyer may still owe the contract price and miss the cheaper spot opportunity. The exact obligation depends on settlement and exit terms.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related