Forward vs Spot Contracts – Key Differences
Buying vegetables now (Spot) vs Ordering a cake for next week (Forward).
1. Concepts
- Spot Contract: Agreement to buy/sell immediately (Settlement in T+1 or T+2 days).
- Forward Contract: Agreement to buy/sell at a future date (e.g., T+90 days).
2. Comparison Table
Spot Market (Cash Market)
- Timing: Immediate delivery/payment.
- Price: Spot Price (Current Market Price).
- Purpose: To own the asset immediately.
- Risk: No counterparty risk (Cash & Carry).
VS
Forward Market
- Timing: Future delivery/payment.
- Price: Forward Price (Spot + Interest).
- Purpose: Hedging future requirements.
- Risk: High counterparty risk.
3. Exam Notes: Writing the Answer
Question: "Distinguish between Spot and Forward Exchange contracts." (5 Marks)
Answering Strategy:
- Time Factor: "Spot = Now, Forward = Future".
- Pricing: "Forward Price includes Cost of Carry (Interest)".
- Settlement: Spot is usually T+2. Forward is T+N.
Summary
- Link:
Forward Price = Spot Price + Interest Cost. They are mathematically linked.
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 4
1. A transaction for immediate delivery is called: