A forward exchange contract (or forward contract) is a binding obligation to buy or sell a certain amount of foreign currency at a pre-agreed rate of exchange, on a certain future date. To take out a forward contract you need to advise us of the amount, the two currencies involved, the expiry date and whether you would like to buy or sell the currency.

Purpose

A forward contract is the simplest method of covering exchange risk because it locks in an exchange rate. This strategy overcomes one of the problems that you can experience when importing or exporting in foreign currency, as you can now budget at a guaranteed rate of exchange.

Pricing

The price of a forward contract is based on the spot rate at the time the deal is booked, with an adjustment which represents the interest rate differential between the two currencies concerned. For example, a company needs to buy US dollars in three months' time, so enters into a forward contract while US interest rates are higher than UK interest rates. In order to meet our obligation under the contract, piagi buys US dollars now, paying for the dollars with sterling. We then pass you the benefit of the higher rate of interest we earn on the dollars. The adjustment to the spot rate means that the forward contract rate would be more favourable than a spot deal rate. The reverse would apply if US interest rates were lower than UK rates.

Summary

A forward contract is an obligation to buy or sell a certain amount of foreign currency at a pre-determined date. Even if your requirements change over the term of the forward contract, you are still obliged to deal.
A forward contract obliges you to deal at a specific rate - you are not in a position to benefit from any favourable movements in exchange rates between booking the contract and completing the deal.
No premium is payable.

Key facts

Minimum deal size: No minimum
Maximum deal size: No maximum
Period: Usually any period to two years - longer periods are available in certain currencies
Currency pairs: Majority of currency pair can be traded freely

Forward in further detail