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FRM Exam Part I · Pricing Financial Forwards and Futures

Forward and Futures Contracts Basics for FRM Part I

Updated 11 October 2026 · Fact-checked

A forward is a private, customised agreement to buy or sell an asset at a fixed price on a future date, settled at maturity. A futures contract is the standardised, exchange-traded version, settled daily through margin. To solve questions, compute the price change times contract size, then apply margin rules.

Understand Forward and Futures Contracts Basics

A forward contract is an over-the-counter (OTC) agreement between two parties. One agrees to buy and the other to sell an asset at a fixed delivery price on a set date. No cash usually changes hands at the start. Terms such as size, date and asset are tailored to the parties. All gain or loss is realised at maturity.

A futures contract does the same economic job but trades on an exchange. Contract size, maturity dates and delivery terms are standardised. A clearinghouse (central counterparty) stands between buyer and seller, so each side faces the clearinghouse and not each other. This cuts counterparty risk sharply.

The key mechanism is daily settlement, or marking to market. Each day the futures price moves, and the gain or loss is added to or taken from your margin account. You post initial margin when you open the position. If the balance falls below the maintenance margin, you get a margin call and must top up to the initial margin level, not just to maintenance. Variation margin is the cash you pay or receive each day.

Payoffs are linear. A long position at delivery price K with spot price S_T at maturity gains S_T − K per unit. A short position gains K − S_T. The payoffs are mirror images, so the total gain of the two sides is zero. Unlike an option buyer, whose loss is limited to the premium, neither party to a forward or futures pays a premium, and both can lose substantially because the payoffs are linear and symmetric.

Because futures are settled daily, gains and losses arrive earlier than in a forward. Most futures are closed out before delivery by taking the opposite position, so few lead to physical delivery. Forwards are more flexible but carry credit risk and are less liquid.

Key formulas to remember

Long forward payoff at maturity
Payoff = (S_T − K) × units
S_T is the spot price at maturity; K is the delivery price. Can be negative.
Short forward payoff at maturity
Payoff = (K − S_T) × units
Mirror image of the long. Long payoff + short payoff = 0.
Futures daily gain or loss
Daily P&L = (F_t − F_(t−1)) × contract size × number of contracts (long); reverse sign for short
F is the futures settlement price. The result goes into the margin account.
Margin account balance
New balance = old balance + daily P&L − withdrawals + deposits
Check it against maintenance margin each day.
Margin call amount
Deposit = initial margin − current balance
Applies when the balance falls below maintenance margin. Top up to initial margin, not to maintenance.
Total futures gain if held to maturity
Total P&L = (F_final − F_initial) × size (long)
The sum of daily settlements. At maturity the futures price converges to the spot price.

How to solve Forward and Futures Contracts Basics questions

Use this sequence for any question on forward and futures basics, payoffs or margin.

  1. 1Identify the instrument: forward (OTC, settled at maturity) or futures (exchange-traded, settled daily).
  2. 2Identify your position: long (buyer) or short (seller). This sets the sign of every gain.
  3. 3Find the contract size and the number of contracts. Multiply per-unit prices by size × contracts.
  4. 4For a payoff question, compute S_T − K for a long or K − S_T for a short.
  5. 5For a margin question, build a day-by-day table: opening balance, price change, daily P&L, closing balance.
  6. 6Compare each closing balance with maintenance margin. If it is below, compute the call as initial margin − balance.
  7. 7Check the answer: a gain for the long is an equal loss for the short, and the sign must make sense.
  8. 8For conceptual questions, link the feature to its risk effect: daily settlement and the clearinghouse reduce credit risk but create liquidity needs.

Quickest way: Margin table in one pass

When to use it: Use for any multi-day margin or marking-to-market numeric question.

  1. Write the daily price changes in a row.
  2. Multiply each by size × contracts and by +1 for long or −1 for short.
  3. Add the running total to the starting balance.
  4. Flag the first day the balance is below maintenance.
  5. Margin call = initial margin − that day's balance, then reset the balance to initial margin and continue.
  6. For payoff questions skip the table: one subtraction (S_T − K) is enough.

Common mistakes in Forward and Futures Contracts Basics

  • Calling the margin call amount maintenance margin minus balance.

    Students link the trigger level with the top-up level.

    Fix: The call restores the account to the initial margin. Use initial margin − balance.

  • Getting the sign wrong for a short position.

    Students apply the long formula to every position.

    Fix: For a short, a rise in price is a loss. Write the position sign before you calculate.

  • Saying a forward needs an upfront premium or margin like an option or future.

    Mixing up derivative types.

    Fix: A forward is normally entered at no cost. Its value at start is zero, with the delivery price set to make that so.

  • Treating futures as having no counterparty risk.

    Students remember the clearinghouse and stop there.

    Fix: Risk is greatly reduced, not removed. The clearinghouse itself and its members can fail, and margin protects against this.

  • Thinking futures and forwards give different total gain with the same price path.

    Daily settlement is confused with a different payoff.

    Fix: Total undiscounted gain is the same in principle. The timing of cash flows differs, which matters for funding and interest.

  • Assuming most futures end in physical delivery.

    Delivery is emphasised in definitions.

    Fix: Most positions are closed with an offsetting trade before delivery. Some contracts are cash settled.

Worked examples

Example 1

A company enters a long forward to buy 10,000 barrels of oil at $80 per barrel. At maturity the spot price is $86. What is the payoff to the long and to the short?

Show the solution
  1. Long payoff per unit = S_T − K = 86 − 80 = $6.
  2. Multiply by size: 6 × 10,000 = $60,000.
  3. Short payoff per unit = K − S_T = 80 − 86 = −$6.
  4. Short total = −6 × 10,000 = −$60,000.

Answer: The long gains $60,000 and the short loses $60,000.

Example 2

You go long 10 futures contracts, each on 100 units, at a futures price of $50. Initial margin is $400 per contract and maintenance margin is $300 per contract. Day 1 settlement price is $48 and Day 2 settlement price is $47. What is the balance after Day 1, and what margin calls arise on Day 1 and Day 2?

Show the solution
  1. Initial balance = 400 × 10 = $4,000. Maintenance level = 300 × 10 = $3,000.
  2. Day 1 change = 48 − 50 = −$2. P&L = −2 × 100 × 10 = −$2,000.
  3. Day 1 balance = 4,000 − 2,000 = $2,000.
  4. This is below $3,000, so a margin call arises on Day 1: deposit 4,000 − 2,000 = $2,000, restoring the balance to $4,000.
  5. Day 2 change = 47 − 48 = −$1. P&L = −1 × 100 × 10 = −$1,000.
  6. Day 2 balance = 4,000 − 1,000 = $3,000. This equals maintenance, not below it, so no call on Day 2.

Answer: The balance after Day 1 is $2,000 (before the call). A $2,000 margin call is made on Day 1, restoring the balance to $4,000. No call arises on Day 2, because the balance of $3,000 equals the maintenance margin.

Exam tips

  • Read the position carefully. Long or short decides every sign, and exam options often include the reversed sign.
  • On margin questions, check whether the call is triggered by 'below' maintenance and whether the top-up is to initial margin.
  • For conceptual items, remember the standard contrasts: OTC vs exchange, customised vs standardised, settlement at maturity vs daily, credit risk vs clearinghouse.
  • Check the units: contract size times number of contracts is a frequent trap.
  • Keep each margin table to a few lines. A basic calculator is enough; the arithmetic is simple, so accuracy matters more than speed.

Practice questions from Pricing Financial Forwards and Futures

Forward and Futures Contracts Basics in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Forward and Futures Contracts Basics: frequently asked questions

What is the main difference between a forward and a futures contract?

A forward is a private OTC contract settled at maturity, while a futures contract is standardised, exchange-traded and settled daily. The daily settlement and clearinghouse make futures much less exposed to counterparty default. Forwards offer tailored terms but carry credit risk.

How does marking to market work in futures?

At the end of each day, the futures position is revalued at the settlement price. The gain is credited to the margin account and a loss is debited. If the balance falls below maintenance margin, you must deposit enough to return to the initial margin.

What is the payoff of a long forward?

It is S_T − K per unit, where S_T is the spot price at maturity and K is the delivery price. It rises one-for-one with the spot price and can be negative. The short's payoff is the exact opposite.

Is initial margin the same as a premium?

No. Initial margin is a performance bond, a collateral deposit that shows you can meet your obligations. It is not a price paid. It is adjusted by your daily gains and losses and is returned when you close the position. An option premium is a non-refundable price paid by the buyer to the seller.