CFA Level I Exam · Forward Commitment and Contingent Claim Features and Instruments

Forward Commitments vs Contingent Claims: Derivatives Basics

Updated 7 October 2026 · Fact-checked

A derivative is a contract whose value depends on an underlying asset or rate. Forward commitments (forwards, futures, swaps) oblige both sides to transact. Contingent claims (options, credit derivatives) give one side a right and the other an obligation. To classify, ask: can either party walk away?

Understand Derivatives Basics: Forward Commitments vs Contingent Claims

A derivative is a financial contract whose value is derived from the performance of an underlying. The underlying can be a stock, bond, index, commodity, currency, interest rate or even a credit event. You do not need to own the underlying to hold the derivative.

Derivatives are used to transfer risk, to gain exposure cheaply, and to help markets discover prices. A company can lock in a future price for a currency it must buy. An investor can gain exposure to an index without buying every stock. Derivatives often need little or no upfront cash compared with the underlying, so they provide leverage. That works in both directions: gains and losses are magnified.

The core split is about obligation versus right. In a forward commitment, both parties are bound to carry out the deal at a set price on a future date. Forwards, futures and swaps belong here. Forwards and swaps are typically priced to have zero value at initiation, so no premium is paid. Futures require margin, which is a performance bond, not a premium. The contract can end with a gain or a loss for either party. In a contingent claim, the payoff depends on a future event or price. The best-known example is an option. The buyer pays a premium and gets a right, not a duty. The seller (writer) takes on the obligation if the buyer chooses to exercise. Credit derivatives such as credit default swaps are also contingent claims, because they pay only if a credit event occurs.

The second split is the market. Exchange-traded derivatives have standardized terms, trade on an organized exchange, and are cleared through a clearinghouse that guarantees performance. They are transparent and have low counterparty risk. Over-the-counter (OTC) derivatives are private, customized contracts between two parties, usually through dealers. They fit exact needs but carry more counterparty (default) risk, less transparency and less liquidity. Regulation has pushed many standardized OTC contracts, especially swaps, toward central clearing.

Key formulas to remember

Forward commitment: Obligation for BOTH parties; payoff can be positive or negative for each; Forwards, futures and swaps. Forwards and swaps are typically priced at zero value at initiation, so no premium is paid. Futures require margin, which is a performance bond, not a premium.
Contingent claim: Buyer: right, pays premium. Seller: obligation, receives premium; Options and credit derivatives. Buyer's loss is limited to the premium; the payoff is asymmetric.
Exchange-traded vs OTC: Exchange: standardized, cleared, low counterparty risk. OTC: customized, private, higher counterparty risk; Customization is the main benefit of OTC; the clearinghouse guarantee is the main benefit of exchange trading.
Long vs short: Long = buyer of the underlying or option; short = seller; For options, 'long' means holding the right; 'short' means holding the obligation.

How to solve Derivatives Basics: Forward Commitments vs Contingent Claims questions

Use this routine for any question that asks you to classify an instrument or compare markets.

1Identify the underlying and the instrument named in the stem.
2Ask whether each party is obligated to transact at a future date. If both are, it is a forward commitment.
3If one party has a choice (a right to exercise), or payment depends on an event, it is a contingent claim.
4Check for a premium paid up front. A premium points to an option, which is a contingent claim.
5For market questions, look for keywords: standardized, clearinghouse and margin mean exchange-traded; customized and private mean OTC.
6Match the risk to the market: counterparty risk is higher in OTC; liquidity and transparency are higher on exchanges.
7Eliminate options that contradict the relevant test (obligation vs right, or market features) and choose the one that remains.

Quickest way: The walk-away test

When to use it: Any stem asking which instrument is a forward commitment or a contingent claim, or which party holds a right.

Ask: does one party have a right to choose whether to transact (the option buyer), or does payment depend on an event?
If so, it is a contingent claim (option, credit protection).
If both parties are bound, it is a forward commitment (forward, future, swap).
For markets: standardized plus clearinghouse means exchange; customized means OTC.

Common mistakes in Derivatives Basics: Forward Commitments vs Contingent Claims

Calling a swap a contingent claim because it has several payments
Multiple cash flows look more complex than a single forward.
Fix: A swap is a series of forward commitments. Both sides are obligated, so it is a forward commitment.
Thinking an option seller has a right
Students focus on the word 'option' for both sides.
Fix: Only the buyer holds the right. The seller (writer) holds the obligation and keeps the premium.
Saying forward commitments cannot lose money for one party
No upfront premium makes them seem free.
Fix: Either party can gain or lose as the underlying moves. No premium does not mean no risk.
Assuming OTC derivatives have no counterparty risk when contracts are customized
Mixing up customization with a guarantee.
Fix: Only a clearinghouse removes most counterparty risk. Private OTC contracts depend on the other party's ability to pay.
Treating derivatives as only speculative tools
Media coverage focuses on losses.
Fix: Remember the purposes: risk management, price discovery, and cost-efficient exposure. Speculation is one use, not the definition.

Worked examples

Example 1

A fund agrees today to buy 1,000 barrels of crude oil in six months at a fixed price of USD 80 per barrel. Neither party pays anything now, and both must complete the trade. Which describes this contract? A. Contingent claim B. Forward commitment C. Exchange-traded option

Show the solution

Underlying: crude oil, with a fixed future price.
Both parties must transact at the agreed price, so there is an obligation on each side.
No premium is paid and no one has a right to walk away.
That is the definition of a forward commitment. Option A needs a right for one party; option C names an option, which is a contingent claim.

Answer: B. Forward commitment

Example 2

Which statement about exchange-traded and OTC derivatives is most accurate? A. OTC contracts are standardized and guaranteed by a clearinghouse B. Exchange-traded contracts have standardized terms and lower counterparty risk C. Exchange-traded contracts can be fully customized to each party

Show the solution

Exchange-traded contracts have standardized terms and a clearinghouse as counterparty to each side, so counterparty risk is low.
OTC contracts are privately negotiated and customized, so they carry more counterparty risk.
A reverses the features of the two markets. C wrongly says exchange contracts are customized.
Only B matches the facts.

Answer: B. Exchange-traded contracts have standardized terms and lower counterparty risk

Exam tips

Every question has three options. Use the obligation-versus-right test to eliminate two quickly.
Expect classification questions: forwards, futures and swaps go in one bucket; options and credit derivatives in the other.
Read who holds the position. 'Buyer of a call' and 'writer of a call' have opposite rights and duties.
Look for keywords such as standardized, clearinghouse and customized to settle market-type questions.
No penalty for a wrong answer, so never leave a question blank.

Practice questions from Forward Commitment and Contingent Claim Features and Instruments

Derivatives Basics: Forward Commitments vs Contingent Claims: frequently asked questions

What is the difference between a forward commitment and a contingent claim?

A forward commitment binds both parties to transact at a set price on a future date. A contingent claim gives one party a right, or pays only if a specified event occurs. Forwards, futures and swaps are forward commitments; options and credit derivatives are contingent claims.

Is a swap a forward commitment?

Yes. A swap is an agreement to exchange a series of cash flows, and both parties are obligated to make their payments. You can think of it as a series of forward contracts.

Why do exchange-traded derivatives have lower counterparty risk?

A clearinghouse stands between buyers and sellers and guarantees performance. It also uses margin requirements and daily settlement to limit losses from default. OTC contracts rely on the other party's credit.

Why would anyone use OTC derivatives if they are riskier?

OTC contracts can be customized to the exact amount, date and underlying a party needs. Exchange contracts are standardized and may not match a specific hedge. Customization is the trade-off for higher counterparty risk and lower transparency.