Forward Trades
Lock in your preferred exchange rate, mitigate risk and start protecting your budget
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
Essential Information About Forward Contracts
How can you use a Forward trade?
Forward trades differentiate from Spot currency trades and regular currency trades and are often used as part of a hedging strategy as they are the most effective way of managing the risk of ever-moving exchange rates, giving you the ability to plan and budget for your overseas payments.
Why might I need a Forward trade?
Forward contracts are helpful for individuals as you may need to pay different amounts on fixed instalment dates. By setting the exchange rate in advance, you can guarantee the amount you will need to pay each time and budget more effectively, protecting the trades against currency risk.
When Do I Use a Forward Contract?
✔ Overseas property purchase
✔ Overseas property maintenance
✔ Transferring savings when emigrating
✔ Destination wedding
✔ International school or university fees
✔ International business cash flows
✔ Importing and exporting goods
Example: Buying a property abroad
Exchange rates fluctuate all the time. The rate you get when you first agree to buy a property internationally will be different from the rate you get when you pay your deposit. It’ll be a different price again when you sign the final deeds of sale and – if you’re buying off-plan – each time you make a scheduled payment during construction.
In the current political climate, any exchange rate movements can be considerable. When it comes to buying property overseas, the difference these exchange rate fluctuations make can add up to thousands of Pounds.
A Forward trade lets you set the exchange rate when it is favourable, at a time that suits you in the property purchase process, so the price of your property will not change by the time you come to pay for it; and any investment is protected.
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.
Currency Forward Contract – FAQs
What is the purpose of forward contracts on currencies?
Forward contracts are customisable contracts between two parties to exchange currencies at a date in the future whilst setting the foreign exchange rate in advance. They enable buyers to make a currency swap (eg. GBP/EUR) for a better rate, by protecting the buyer from fluctuations in currency prices.
What is a forward premium?
A forward premium occurs when the expected future price for a currency is greater than the spot price. This situation indicates that the current domestic exchange rate is going to increase against the currency it’s paired with.
What’s the difference between a forward contract and a futures contract?
A forward contract is a private arrangement and the contract is customised to the individual needs of the buyer. A futures contract is traded with standardised terms on an exchange such as the London Stock Exchange.
What is the difference between a forward contract and a spot contract?
A forward exchange contract allows you to secure the current exchange rate for the future, whilst a Spot contract is settled and paid for immediately at the current FX rate.
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