Currency Forward
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.
Related terms:
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