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.
Forward Contracts
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 one ton of gold one year from today. On the other hand, bank B currently owns one 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 to occur.
Futures Contracts
A futures contract is a contract between two 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.
Swaps
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 an underlying financial instrument, such as currencies and commodities, and the exchange of the underlying instrument occurs at a future date.
