What Derivatives are Types of Forward Commitments?

A derivative is a type of security in which the price of the security is dependent on underlying assets. A derivative could have a forward commitment, which is an agreement to buy or sell an asset at a future date at a predetermined price. There are three main types of derivatives with forward commitments: forward contracts, futures contracts and swaps.

A forward contract is a contract between two parties that dictates which party buys or sells the underlying asset at a predetermined price on a future date. A forward contract could be tailored to any asset and delivery date. It is considered a derivative because its price depends on the price of the underlying asset.

For example, assume bank A wants to buy 1 ton of gold one year from today. On the other hand, bank B currently owns 1 ton of gold that it wants to sell one year from today. Both banks could enter into a forward contract and agree on a price and date for the transaction would occur.

A futures contract is a contract between to parties that agree to buy or sell a particular underlying asset at a predetermined price in the future. A futures contract is standardized and trades on a futures exchange. The price of a futures contract is derived from the price of an underlying asset and also has a forward commitment; the purchase or sale of the underlying asset occurs on a future date.

A swap is another derivative that has a forward commitment. A swap is an agreement between two parties to exchange a series of future cash flows and is tailored to meet the needs of each parties. Swaps depend on a underlying financial instrument, such as currencies and commodities, and the exchange of the underlying instrument occurs at a future date.