Forward Contract Sale Definition

A forward contract sale is a contractual agreement between two parties to buy or sell a specific asset at a predetermined price and time in the future. This type of agreement is common in commodity markets, such as oil, gas, gold, and agricultural products.

Forward contracts are commonly used to hedge against the risk of price volatility in these markets. For example, if a farmer anticipates a bumper crop of corn but is worried about the price falling by harvest time, they may enter into a forward contract with a buyer to sell their crop at a set price in the future.

The predetermined price in a forward contract is known as the delivery price, and the date on which the contract will be executed is known as the delivery date. Unlike futures contracts, which are standardized and traded on exchanges, forward contracts are customized agreements between two parties.

Forward contracts can provide benefits to both the buyer and the seller. For the buyer, entering into a forward contract can provide price protection against future price increases, allowing them to lock in a lower price. For the seller, a forward contract can provide price protection against future price decreases, allowing them to lock in a higher price.

However, there are also risks associated with forward contracts. If the price of the asset being sold increases beyond the delivery price, the seller may miss out on the opportunity to sell at a higher price. Likewise, if the price of the asset decreases beyond the delivery price, the buyer may be stuck buying at a higher price than the market value.

Overall, a forward contract sale is a valuable tool for reducing risk in commodity markets. By locking in prices and delivery dates, both buyers and sellers can protect themselves against price volatility and uncertainty.