What is a Currency Forward Contract?
A currency forward contract is a customisable derivative contract between two parties that lets you set a favourable exchange rate in advance for your preferred currency pair for a future date. Unlike a spot contract where the amount owed is settled immediately, forward trades are a ‘buy now, pay later’ type of currency trade. Currency forward contracts are a hedging tool used by foreign exchange specialists to allow buyers to take advantage of the volatile foreign exchange market and to protect buyers’ trades against currency risk.
Benefits of a Forward Contract:
✔ Currency exchange is available in the majority of freely tradable currencies
✔ Set the exchange rate now; settle the currency trade up to 24 months in the future
✔ Protect against moving exchange rates during your chosen time frame
✔ Easy tool to help manage exchange rate fluctuations from downturn and upturns in the currency market
✔ Protects business profits from foreign exchange market downsides
How Do Forward Contracts Work?
To make a Forward trade, you agree to exchange a specific amount of one currency for another at a fixed exchange rate, then settle that trade on a date you have chosen. The trade date that you’ll settle your forward exchange rate can be up to 24 months in the future.
- You set the amount of currency required, the exchange rate and the settlement date on the day that you agree to the trade, avoiding the exchange rate risk during that time. You simply pay a small deposit to secure the exchange rate, and then no payment is required until the agreed settlement date for the trade.
- Currency trades can be booked against most freely tradable currencies and not just against Pounds Sterling.
- In practice, the ability to set an exchange rate in advance in this way guarantees the amount of currency that you will need to pay for or receive in exchange for a given amount of foreign currency, regardless of what happens to exchange rates between the date you agree to the transaction and the settlement date.
- You can also make multiple payments from the initial lump sum and set the length of the Forward trade for a time that suits your needs, giving you complete payment flexibility.
Because the exchange rate is fixed, your exchange rate will be protected from currency movements during the time you have agreed. This is ideal for future payments at times when exchange rates are uncertain, so your money is protected from unfavourable currency market movements between now and the time you need to make your international payment.
By fixing the exchange rate in advance, you can eliminate the risk of currency rate changes on your international transactions. You will be able to calculate the value of all your future transactions within the period of the Forward trade with certainty, taking the stress out of continuing international transfers.
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