Briefly distinguish between a forward foreign exchange contract and a currency futures contract.
What will be an ideal response?
POSSIBLE RESPONSE: Currency futures and currency forward contracts are financial contracts that are similar in nature but do have important differences. The main difference is that currency futures contracts are highly standardized and traded on an exchange, whereas currency forward contracts are tailored to meet the specific requirements of the buyer or seller. Currency forward contracts are not traded on an exchange, but over-the-counter.
Currency futures contracts are standardized because the expiration date and contracted amounts are predetermined. For example, euro (EUR) currency futures contracts are available with quarterly expiration dates in the months of March, June, September, and December and the contract size of each euro future is set at €125,000. Forward contracts, on the other hand, are not restricted by size or expiration date. These are determined by the buyer and seller to meet a specific or unique requirement. With a currency futures contract, investors have to pay for the contract and may need to post margin requirements. With a currency forward contract, no initial outlay is needed and collateral is generally not required. An exchange clearing house acts as the counterparty to both the buyer and the seller of a currency futures contract and requires margins to be posted. Currency futures contracts are "marked to market" daily. Since currency forward contracts are settled at the time of delivery, the profit or loss is only realized at the time of settlement. A loss that results from default is much greater for participants in a forward contract. Futures contracts can be traded in a secondary market, whereas there is no secondary market for forward contracts.
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