Currency Forward
Currency Forward Explained:
- What are currency forwards?
- What is a forward contract
- How to hedge currency risk with forward contracts example
- FAQ's
What are currency forwards?
Foreign exchange (FX) forward is a derivative contract that involves the exchange of two different currencies on a specific future date at a fixed rate.
The fixed rate is agreed at the inception of the contract.
What is a forward contract?
A forward contract is a bespoke bilateral contracts between two parties to buy or sell a underlying asset (such as currency) at a specified price and at a later date.
Forward contracts are fully flexible in terms of notional amounts and maturities, although one-month or three-month forwards are most commonly used for hedging purposes due to better liquidity and lower transaction costs.
How to hedge currency risk with forward contracts example
- A UK business sells £100,00 worth of products to a client based in the United States.
- They will receive payment in two months, however during this time they expect the USD to rise against GBP.
- The business therefore enters into a forward contract to lock in the current exchange rate and settle in two months time.
FAQ's
Are FX forwards OTC derivatives?
Yes, FX forwards are over-the-counter (OTC) derivatives, established bilaterally between two counterparties. They are not traded on centralised exchanges and are considered OTC instruments.
What is the difference between a forward rate and spot exchange rate?
The difference between a forward rate and the spot exchange rate mainly derives from the interest-rate differential between the two currencies based on the tenor of forward date. It can also be affected by the cross-currency basis.
What are the benefits of currency forwards?
- Mitigates FX risks by locking in an exchange rate for settlement at a future date, eliminating the effects of exchange rate volatility.
- Provides certainty in forecasting cashflow.
Related terms:
What is MillTechFX?
We provide access to a transparent marketplace for comparative FX execution from up to 15+ counterparty banks, while harnessing a unique and significant pricing efficiency for our clients and reducing their operational burden. In addition, MillTechFX provides clients with full transparency of execution via independent TCA reporting.
