Cash Forward Sale
A cash forward sale is a bilateral contract in which a seller agrees today to deliver a specific quantity of a commodity, currency, or financial instrument to a buyer at a predetermined price on a specified future settlement date, with full ownership transfer and payment occurring at maturity rather than at contract inception.
Key takeaways
- Unlike futures, cash forward contracts are customizable, OTC agreements with no exchange clearing, margin requirements, or standardized settlement dates.
- The forward price reflects the spot price plus cost of carry: F = S × e^(r + u − y) × T, where u is storage cost and y is convenience yield.
- Cash forwards are widely used by agricultural producers (farmers locking in crop prices), manufacturers (hedging raw material costs), and exporters (locking in FX conversion rates).
- Counterparty credit risk is the primary risk distinguishing forwards from exchange-traded futures.
- Settlement can occur via physical delivery of the underlying asset or via cash settlement at the difference between forward price and spot price at maturity.
Explanation
A cash forward sale obliges the seller to deliver the underlying asset at the agreed forward price F on the settlement date T, and obliges the buyer to pay that price. The contract is binding with no daily mark-to-market or margin requirements — both parties simply wait until settlement. The forward price is set at contract inception such that the net present value of the forward is zero to both parties, meaning: F = S × e^(r + u − y) × T, where S is the current spot price, r is the risk-free financing rate, u represents storage costs (relevant for physical commodities), and y is the convenience yield (the premium of holding the physical commodity for immediate delivery).
For commodities, the cash forward sale is the primary hedging tool for producers. A wheat farmer expecting to harvest 100,000 bushels in September can lock in the current September forward price (e.g., $6.20/bushel) today in June, guaranteeing revenue of $620,000 regardless of where spot wheat prices are at harvest. If spot prices fall to $4.80 at harvest, the farmer's forward sale generates $140,000 more than market price — the hedge has worked as intended. If prices rise to $7.50, the farmer forgoes $130,000 of upside, but the certainty of revenue may be worth that cost given the farmer's leverage and operating cost structure.
In foreign exchange, the FX forward market is the most liquid segment of the global FX market, with daily turnover in excess of $3 trillion. Exporters use FX forward sales to lock in the dollar value of future foreign currency receivables. A U.S. company expecting €10 million in sales proceeds in six months can sell euros forward at today's six-month forward rate (determined by the spot EUR/USD rate and the interest rate differential between EUR and USD interest rates — the covered interest rate parity condition). This eliminates FX uncertainty from the revenue projection.
Credit risk (also called counterparty risk or settlement risk) is the critical distinguishing feature of OTC forward contracts versus exchange-traded futures. In a forward contract, both parties are exposed to the risk that the counterparty will default before settlement. ISDA master agreements with credit support annexes (CSAs) mitigate this by providing netting, termination rights, and collateral posting. For large transactions, the bilateral credit exposure of an unsecured forward can be substantial, particularly if the position has moved significantly in one direction since inception.
Forward contracts also exhibit basis risk when used as proxy hedges. A corn producer hedging through CBOT corn futures or standardized forwards faces basis risk if the local cash price for their specific corn grade in their delivery location diverges from the benchmark forward price. Managing basis risk requires understanding local supply-demand conditions and seasonal price patterns.
Formula
F = S × e^(r + u − y) × T
Example
A Brazilian soybean producer has 50,000 metric tons of soybeans expected at harvest in April. In October, with soybeans trading at the Chicago Board of Trade equivalent of $380 per ton, the producer sells 50,000 metric tons via a cash forward sale to an international grain trader at $385 per ton (including a $5 premium for the specific quality and location), locking in revenue of $19.25 million. By April, a bumper crop in South America pushes spot soybean prices to $310 per ton. The producer delivers at $385/ton, earning $3.75 million more than if they had sold at spot, validating the hedging decision despite the forgone premium had prices risen.
Related terms
Basis Basis Risk Board Of Trade Counterparty Risk Credit Risk Default Delivery Exchange Floor Forward Contract Forward Market Futures Contract