Get Up to 30% OFF New Silver Collection MenWomen * Limited time only.

What Is Forward Currency Contract

What Is Forward Currency Contract

A forward currency contract, sometimes referred to as a currency forward, is an agreement between two parties to exchange a specific amount of one currency for another at a predetermined exchange rate on a future date. This type of contract is commonly used by businesses and investors to manage their foreign exchange (forex) risk.

The forward rate is based on the current market rate, adjusted for the interest rate differential between the two currencies. This means that the forward rate will differ from the spot rate (the current market rate) at the time the contract is entered into. The difference between the two rates is known as the forward points.

Businesses may use forward currency contracts to hedge against forex risk. For example, if a company in the United States has a contract to supply goods to a company in Europe in six months’ time, the US company faces currency risk if the euro devalues against the dollar in the meantime. The US company could enter into a forward currency contract to buy euros at a specific rate on the date of the contract, thereby locking in the exchange rate and reducing the risk of loss due to currency fluctuations.

Investors may also use forward currency contracts for speculative purposes. For example, if an investor believes that the euro will appreciate against the US dollar in six months’ time, they could enter into a forward currency contract to buy euros at a specific rate on that date. If the euro appreciates as expected, the investor will profit from the difference between the forward rate and the spot rate at the time of the contract.

It’s important to note that forward currency contracts are not standardized, meaning that the terms of the contract can vary greatly between parties. The contract may include specific terms on the currencies being exchanged, the amount being exchanged, the delivery date, and the exchange rate. Forward currency contracts are also typically settled in cash rather than the physical delivery of currency.

In summary, a forward currency contract is an agreement to exchange a specific amount of one currency for another at a predetermined rate at a future date. Businesses and investors use forward currency contracts to manage forex risk or for speculative purposes. The terms of the contract can vary greatly between parties, and forward currency contracts are settled in cash rather than physical currency.

Share this post