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What is a forward currency contract?

Image of Leanne Macardle

Leanne Macardle

Freelance Contributor

Rupi Currency Notes

Whether you’re transferring money abroad for business purposes or personal reasons, you may have come across the term forward currency contract. This kind of arrangement can be a great way to give you some certainty when it comes to exchange rates and costs while avoiding currency fluctuations, but what exactly is a forward currency contract, and how can you make it work for you? We take a look.

What is a foreign exchange forward contract?

A currency forward contract (or foreign exchange forward contract) is a written agreement between two parties to buy or sell foreign currency on a specified future date at a pre-agreed price. The currencies to be exchanged have to be agreed in advance, as does the exchange rate (which will be based on the rate at the time you make the contract) and the eventual date the transfer is to be made, at which point the transfer will happen automatically.

Essentially, it’s a way to buy the currency now and send it later, allowing you to avoid market volatility in the interim period and lock in the price you pay, which has the potential to save you money.

When would I use a currency forward contract?

You may need to use a forward currency contract if you make regular international money transfers in a business capacity, perhaps to pay staff overseas or import/export goods, for example. By locking in an exchange rate and transfer date ahead of time, you can plan your costs more effectively, giving you a greater level of certainty when it comes to your cashflow.

Yet it can be just as beneficial in a personal capacity, perhaps if you’re buying property overseas and need to make sure a payment will arrive on a set date, or if you regularly send money to support a family member living abroad. In both of these scenarios, you can again benefit from payment certainty, which can be particularly beneficial in the case of a property purchase where you need to make sure that an exact amount is transferred.

How does a forward currency contract work?

Here are the steps to arranging a forward currency contract:

  • Get set up with a specialist money transfer provider
  • Specify the currencies you’d like to exchange and receive a quote from the provider based on the current exchange rate.
  • Select the date on which the transfer is to take place (in some cases this can be arranged up to two years in advance).
  • Provide all necessary payment information, as well as the details of the recipient. You may also need to make a deposit, with the remainder to be paid on the contracted date.
  • On the pre-agreed date, the transfer will be triggered automatically, and the currency will be converted at the agreed rate and delivered to the recipient.

Currency forward contract advantages and disadvantages

  • You can avoid fluctuations in the currency market by locking in your exchange rate in advance, allowing you to hedge risk and ensure you’re making the most of your money by avoiding upward or downward movement in rates.
  • It means you can plan ahead and ensure that payment will be delivered at a certain time – giving valuable peace of mind that a key date won’t be missed – while knowing exactly how much will be leaving your account and how much will be delivered in foreign currency.
  • Limited flexibility. You’re tied into the exchange rate ahead of time, which means if the markets work in your favour in the intervening period, you miss out on those gains and it could end up costing you more than if you’d have waited.

Ultimately, the benefit of forward currency contracts can also be its downfall – by fixing a rate in advance you’re protected from losses, but will also miss out if currency values improve, so it’s arguably a bit of a gamble.

Yet for those who need to transfer money regularly, or who have a particularly large transfer coming up, using a forward contract to hedge currency risk could prove beneficial. Not only can it give you certainty – both in terms of dates and payment amounts, allowing you to budget effectively as well as plan your calendar – but it also has the potential to save you a lot of money, particularly if the market has moved against you in the prevailing time period. This is especially true in the case of substantial transfers, where even a slight fluctuation in exchange rates can have a significant impact on the eventual amount paid.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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