Explain what you mean by a forward contract?

Explain what you mean by a forward contract? 

Ans. A forward contract is a customized contract between two entities, where settlement takes place on a specified date in future at a pre agreed price fixed today. 

It has flourished in many countries including India for centuries. 

It is a bipartite contract. There are four variables in a forward contract. 

(a) The Underlier; 

(b) The notional amount; 

(c) The delivery price; 

(d) The date on which settlement will take place between the underlier and exchange. 

There is an element of flexibility in a forward contract but its biggest limitation is the credit or default risk.