What distinguishes a futures contract from a forward contract?

The distinguishing feature of futures contracts compared to forward contracts lies in the trading environment in which they operate. Futures contracts are traded on organized exchanges, which provides a standardized framework for the contracts. This means that the terms of futures contracts, such as the quantity and quality of the underlying asset, are predetermined and uniform for all participants.

Trading on an exchange also brings significant advantages, such as enhanced liquidity and the presence of clearinghouses that mitigate counterparty risk through daily settlement processes. This structured environment contrasts with forward contracts, which are typically negotiated privately and are more customizable, containing terms that can differ significantly from one contract to another. The lack of a centralized market for forwards increases the risk of default by either party involved, as there is no intermediary to facilitate the transaction.

In summary, the key difference highlighted by this choice is the fact that futures contracts are exchanged in a regulated market, providing standardized terms and reduced risks, while forward contracts are more flexible but also carry higher counterparty risk due to their private nature.