Suppose a manufacturer of class rings is gathering orders to fill for this school year and wishes to ensure a price for gold to be delivered six months from now, when the rings will actually be manufactured. The spot (current) price of gold is not the manufacturer’s primary concern because the gold will not be purchased until it is needed for the manufacturing process. However, to reduce the risk involved with the future price of gold, the manufacturer wishes to contract now for the needed gold. Having a guaranteed price for gold will allow the manufacturer to price its rings more accurately.

Our manufacturer could find a gold supplier (e.g., a gold mining firm) who was willing to enter into a forward commitment or contract, which is simply a commitment today to transact in the future. The supplier agrees to deliver the gold six months from now at a price negotiated today. Both parties have agreed to a deferred delivery at a sales price that is currently determined; however, no funds are exchanged. Both parties have reduced their risk because the supplier knows what it will receive for the gold when it is sold six months from now and the ring manufacturer knows what it will pay for the gold when it takes delivery six months from now.