Essential

Forward

A contract to exchange currencies at a pre-agreed rate on a specific future date, used to hedge against currency risk.

Definition

A forward contract is an agreement between two parties to exchange a specified amount of currency at a predetermined rate on a set future date. Unlike spot transactions that settle in two business days, forwards can settle weeks, months, or years ahead. Businesses use forwards to lock in exchange rates for future payments, eliminating uncertainty.

How It Works

Two parties agree on the currency pair, amount, exchange rate, and settlement date
The forward rate = spot rate plus or minus forward points (interest rate differential)
If the higher-yielding currency is the base, forward points are subtracted (discount)
On settlement, currencies are exchanged at the agreed rate regardless of current spot rate

Trading Tips

Forward rates are not predictions of future spot rates. They simply reflect interest rate differentials.

Businesses should use forwards to lock in rates for known future payments rather than speculating

Non-deliverable forwards (NDFs) settle in cash and are used for restricted currencies like CNY or INR

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