Forward Contract Foundations · Forwards Trading Guide
Settlement determines what must actually move at maturity. A calculated gain is not always the cash that arrives in the bank account.
Physical settlement exchanges the underlying
A deliverable EUR/USD forward can require one party to pay dollars and receive euros. A physical commodity forward can require goods meeting stated quality and location terms. The economic gain against the market does not replace these gross obligations unless the contract permits another settlement method. A profitable position can still require a large outgoing payment.
Cash settlement uses a reference
A cash settled forward exchanges a calculated difference rather than the underlying quantity. Suppose a fictional agreement covers 500 units at $40 and settles against a published reference of $43. The long receives $1,500 under a simple linear dollar payoff. The agreement must identify the reference, observation time, correction process and payment date. A different reference can produce a different outcome.
Keep commercial purchases separate
If the business still needs the physical product, a cash settlement does not deliver it. Paying $21,500 for 500 units in the spot market and receiving $1,500 from the forward gives a combined $20,000 cost before fees, provided the spot purchase matches the reference. Transport, quality and timing differences can prevent the offset from being exact.
Build a settlement checklist
Confirm currencies, bank instructions, time zones, cutoffs and whether holidays shift observation or payment. Distinguish a fixing date from a payment date. Arrange the gross amount required, not merely the expected net gain. Review disputed or unavailable reference procedures before trading. Operational failure can create a loss even when the original price view proves correct.
Try it yourself
A deliverable contract buys EUR 50,000 for $55,000. The euros are worth $57,000 at maturity. Can the buyer assume it only receives $2,000?
Show the worked answer
No. Under physical settlement it pays $55,000 and receives EUR 50,000. Receiving only the difference requires the relevant cash settlement or termination arrangement.
Further reading
Educational material. Numerical examples are hypothetical and exclude costs unless stated. Forward contracts create binding obligations and may require collateral or credit approval. Actual terms, access and risks depend on the agreement and jurisdiction.
