BER Currency News

BER Home/s

  1. Forex Guides
  2. Business FX
  3. Forward Contracts

What Is a Forward Contract?

In this guide we take a look at FX Forward Contracts and when they are a good idea to manage your currency market risk.

An FX forward contract is a tool for hedging against adverse movements in foreign exchange rates.

Simply, it is an agreement made today to change money at a fixed, known exchange rate at some time in the future. The ‘forward rate’ used will be today’s exchange rate adjusted slightly by the ‘forward points’ – an adjustment necessary to account for interest rate differences between the two currencies in play.

The main motivation for using an FX forward has always been to lock in advantageous exchange rates. Once locked in, money can be changed at a time of your choosing – up to three-years in the future with certain providers.

Forward contracts are extremely common in business and increasingly are being used by non-business users expecting to receive or pay large sums in foreign currency, such as those buying or selling property overseas.

Forwards are considered ‘over the counter’ derivatives and, according to the Bank for International Settlements’ most recent survey, make up around 14% of the total $5 trillion per day in FX trade volume.

A Very Forward Example

Marie is from the US but is buying an apartment in Singapore. She’ll be sending funds to complete payment of SGD 600,000 in one-month’s time. If the money were sent today she’d be paying USD 426,000 given today’s SGD/USD exchange rate of 0.71.

Marie is worried that the value of the Singapore dollar might appreciate between now and the day she sends funds. If, for example, the SGD/USD rate were to rise to 0.74 in a month’s time, she’d face a payment of USD 444,000, or USD 18,000 more than what she’d pay today.

Marie enters into a one-month forward contract to buy SGD 600,000 with US dollars at a forward rate equal to today’s exchange rate plus/minus the forward points, which in Marie’s case is: 0.71 + 0.0023 = 0.7123.

One month later…

Marie completes her payment with a transfer of USD 427,380 at the agreed rate of 0.7123.

Marie considers herself lucky because the Singapore dollar did strengthen and with today’s best value FX provider Marie is quoted USD 442,500. Marie has saved USD 15,120!

Forward Deposits

To protect the counterparty, upon entering into a forward contract you will need to pay a deposit – typically 10-20% of the total funds.

The deposit may vary depending on the currencies in question. Forwards involving the more stable currencies of the major developed nations, such as euros into British pounds, may require lower deposits than forwards involving emerging market currencies or currencies which have less active participation (are less ‘liquid’), such as euros into the Brazilian real or the South Korean won.

Other Characteristics of FX Forwards

  • Forwards work well when definite sums are in play, with certainty over timing – when, for example, you know that you’ll be sending $50,000 in three-months’ time.
  • You have to be much cleverer with forwards if hedging smaller, irregular amounts coming in at uncertain times, such as those amounts you might receive as a retailer. In these cases, forwards are not as useful.
  • Unlike FX options, forwards offer no upside should the exchange rate move in a favourable direction.
  • When entering into a forward contract, you are essentially making a bet on the foreign currency against the direction which benefits you. You can imagine it this way: if, in our scenario above, the value of the Singapore dollar fell, making it cheaper to buy the apartment, your on-paper “win” would be offset by your “losing bet” on Singapore dollar appreciation – a bet you made via your forward.
  • Some forward providers will allow you to utilize your forward (change money) earlier or later than the originally agreed date. Readers should be aware that such adjustments to the initial forward contract must be paid for. The forward provider is, strictly speaking, ‘rolling’ you from one forward to another and, most likely, a new forward exchange rate will have to be implemented.
  • Forwards, unlike ‘spot’ exchange rates, are not priced transparently.
  • Any of us can compare exchange rates quoted by the bank to popular websites such as www.xe.com, or better still, use Best Exchange Rates’ comparison calculators to compare against providers of travel money and foreign currency transfers, but this is not so easily done with forwards.
  • Although not particularly complex, the calculation of the forward rate may be a little beyond most people (and is beyond the scope of this article), or an inconvenience. This allows sneaky banks to easily pad their margins, or their ‘spread’ above/below the true valuation of the forward.
  • Nobody would deny the forward provider a profit on their services, but too much is…well, too much. The best way to satisfy yourself that you are on the receiving end of an appropriately priced forward is to use one of Best Exchange Rates’ trusted partners.

Best Exchange Rates’ Trusted Forward Providers

If you believe that a forward contract is suitable for you, we highly recommend using one of our trusted partners – OFX or World First. Both companies are experts at what they do, which is to facilitate international payments with minimal fuss and without bogus fees or margins.


David Brown Author: David Brown

David has extensive experience in foreign exchange markets after multiple roles at investment banks and fintech startups in London and Sydney. He founded the BER platform with the goal of providing Retail and SME customers access to the same exchange rate transparency and competition previously only available to larger institutions. BER is now the leading specialist FX comparison website in Australia and a growing list of countries.

BER logo Best Exchange Rates - We make it Easy to Compare Exchange Rates & Fees of Banks and Currency Exchange & Payment Providers


Level 2, AMP Tower, 50 Bridge Street, Sydney, NSW 2000, Australia

Disclaimer | Copyright | Privacy Statement


DISCLAIMER

Best Exchange Rates is an information only service. By browsing on the website, using our comparison tools or FX provider referral service, you are asking Best Exchange Rates to provide you with information about currency exchange products & services from multiple financial institutions.

We will try to show you a range of products & services in response to your request for information. The search results do not include all providers and may not compare all features relevant to you. In giving you product information we are not making any suggestion or recommendation to you about a particular product.

If you decide to conduct foreign exchange you will deal directly with a financial institution, and not with Best Exchange Rates. Rates and product information should be confirmed with the relevant financial institution, see our terms of use for further details.

Best Exchange Rates may receive fees or other benefits in relation to activity on the Best Exchange Rates website. Best Exchange Rates may receive remuneration for vendor referral links. Please note that the opinions of our authors are their own and do not reflect the opinion of Best Exchange Rates and should not be taken as a reference to buy or sell any financial product.

Read our Full Terms of Service



COPYRIGHT

This website and its contents are the copyright of BEST EXCHANGE RATES PTY LTD © 2009-17. All rights reserved.

Any redistribution or reproduction of part or all of the contents in any form is prohibited other than the following. You may print or download contents to a local hard disk for your personal and non-commercial use only. You may copy some extracts only to individual third parties for their personal use, but only if you acknowledge the website as the source of the material.

You may not, except with our express written permission, distribute or commercially exploit the content. You may not transmit it or store it on any other website or other form of electronic retrieval system.

For more details or request distribution right please contacxt us here.