Explain the key differences between an options contract and a forward contract. For each contract, give an example of how it might be used by a firm.

The key differences are (1) a forward contract obligates both parties to act while the options contract is exercised only if the buyer so chooses and (2) an option premium is paid by the buyer to the seller at the time an option contract is entered whereas there is no such payment on a forward contract. The examples given by students will vary but should illustrate these two key differences.