Forward Contract
A private deal to exchange later at a locked rate: hedging without an exchange.
A forward contract locks a future exchange rate privately between two parties. Custom dates and size, no exchange, bank credit does the guaranteeing.
A forward contract is an over-the-counter agreement between two parties to exchange an asset at a set price on a set future date. Unlike futures, terms are customized and there is no clearing house: counterparty trust and bank credit lines do the guaranteeing.
How It Works
- Custom amount and date, negotiated bilaterally
- Rate equals spot plus forward points
- Settles once at maturity
Trading Tips
Compare two banks: forward pricing varies more than spot
Match dates to real cashflows exactly
Mind counterparty risk outside clearing
Forward Contract Example
Say a UK firm must pay suppliers $2 million in six months. It locks 1.27 forward today, fixing costs to the penny. Sterling then rallies 5%: the firm overpaid versus spot and slept perfectly anyway. That trade is the product.
How Traders Use Forward Contract
Use forwards to delete currency risk from known payments, never to speculate. The regret of a better spot later is the premium for certainty. Hedge ratios, not hunches, set the size.
Related Terms
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