This beginner’s guide will help readers understand the concept behind currency forward contracts, a currency hedging tool. We explain the pricing methodology which determines forward exchange rates and we will evaluate the best choices to buy currency forward contracts for business FX services and to buy currency forwards for private FX services. Please note a forward currency contract is not an FX Limit order in spite of some similarities.
FX Forward as an Essential Risk-management Tool
[The 6 Ground Rules of Currency Forwards]
- Currency forward contracts allow investors to buy or sell a currency pair for a future date and guarantee the forward exchange rate that will be received at the time the transfer is to be made. With a forward exchange contract you guarantee the current exchange rate for the future, unlike a Spot Transaction which is settled immediately at the current foreign exchange rate.
- Currency forward deals are an extremely important tool in minimising exchange rate risks associated with major transactions such as overseas house purchases.
- Companies can also buy currency forward contracts to guarantee both cost and revenue streams in domestic-currency terms.
- Usually, around 10% of the contract value is due upfront when you buy the currency forward with the rest deliverable when the currency forward contract matures.
- FX forward contracts can be taken out for up to one-year ahead for all major currency pairs and for periods of five years or longer for the most important pairs such as GBP/USD and EUR/GBP. Some providers offer longer Forwards and it’s worthwhile to inquire with multiple companies about your specific needs.
- Currency forwards are offered by banks for large corporate customers but usually not to SME nor private clients. FX Forwards are are readily available by international money transfer companies for any .
When to buy a currency forward
- You or your business is due a payment in foreign currency in the future and you want to fix it to your local currency that you use for expenses. You don’t want to lose a chunk of that payment due to currency movements.
- You have to make future payment (or payments), and you want to know exactly what you would have to pay in your domestic currency.
- You or your business owns a large amount of foreign exchange and you don’t want to risk losing if rates move against you.
Buying a Foreign Exchange Forward Contract
Corporations / SMEs / Individuals all welcomed
If you require corporate FX services you can view the following companies which have been reviewed by us and are recommended both in terms of the fees they take and the level of service they provide. This is the list of top 3 best Forward Exchange Contract service providers:
- Operating Since 1979 - First Commercial FX Firm
- Corporate FX Specialists
- Great Online Platform, Tailored for SMEs
- Many Consumer and Business Awards
- Widest Selection of FX Hedging Tools
- Best Credit Score by D&B
- Large Transfers and Bespoke Business Transfer Specialists with 4.5/5 Rating on TrustPilot (5,000+ Reviews)
- Industry Leader with £10bn in Annual Turnover
- Batch Payments and Forward Contracts Online
- Risk Management including Rate Alerts and Forwards
- Most Global Offices in the Industry
- Easy On-Boarding Process
- No Transfer Fees and Great Rates
- Accepts Private Clients and Business Clients of Any Requirement
- Smooth Online and System
- Personal, Friendly Service
- High TrustPilot Rating
- Regular Market Updates
- Expert Guidance by Veteran Dealers
- Excellent Hedging Offering for Businesses
- Property Transaction Specialists
- 99% Positive Customer Feedback
- Known for Great Currency Guidanc
- Highly Usable and Friendly Website
- Operating for 15+ Years
- Result of a Merger of two Leading Companies in the Money Transfer Space, One was Fully Dedicated to Corporate Foreign Exchange
- Traded Publicly on the Australian Stock Exchange
- Massive Staff
- Spotless Reputation for 20 Years
- Ultra Professional System with High Level of Functionality
- Very Tight Margins
- Transparent Rates on the Online System
- Best Rates: Fixed FX Spreads of 0.1% – 0.5%.
- Authorized by 6 Global Regulators
- Asian Currency Specialists
- Excellent Multi-Currency Offering for Online Sellers
- Operating for 15+ Years
- Owned by Ant Financial, a Global Payments Giant
- Courteous Staff
- Largest Selection of Currencies
- Does not Accept USA-Based Clients
Currency Forward Contract FAQ
FX Forward Contract or FX Swap?
If you want to read more about the comparison of FX Forwards and FX Swaps go here.
Forward Contract vs Futures Contract
If you are trying to understand the difference between an FX forward contract vs Future contract then it is quite easy to see how the two fit together.
Future contracts or ‘futures’ are financial contract derivatives that obligate two parties to transact an asset at a predetermined future date and price. They originated in the 19th century when farmers sought to guarantee a future sale price for their goods.
Forex futures are just one type of future contract. So the difference between forwards and futures is simply that FX forwards are just one part of futures as a whole. You will also find commodity futures (such as crude oil, gas and wheat), stock index futures and bond futures (i.e. UK/US treasury bonds).
Forward Contract Pricing – Calculating Forward Exchange Rates
The pricing of a currency forward contract is a relatively straight-forward concept based on three factors. The first factor is the current spot rate for the currency pair, the second factor is the interest rate differential between the two currencies involved in the trade (e.g. the difference in the base interest rate in the UK & EU for GBPEUR trades) and the third is the time until the contract matures.
If the pricing of a currency forward contract differed from these principles, there would be an arbitrage opportunity as investors would be able to take advantage of the difference in interest rates to trade forward contracts and make a profit.
No Judgement in Forward Exchange Rates
It is tempting to assume that a forward exchange rate carries some kind of implicit forecast surrounding potential currency movements. However, this is not the case, as the forward rate is a purely mechanical function of interest rate differentials, the time to duration for the contract to mature and the current rate.
Even if a currency appears substantially out of line with fundamentals, the forward rate will not make assumptions of any kind of correction, forecast or mean reversion.
This is different to the situation in the options market where there is always an implied judgement of future trends expressed in demand and supply.
Advantage of Using Forwards
The most important reason for using a currency forward contract is that it eliminates uncertainty and risk. From an individual perspective, the most likely scenario for using a forward contract would be when buying property abroad.
If, for example, a British individual buys a house in France the purchase price will be determined in Euros. There is, however, an important delay between agreeing to buy the property and the actual transaction taking place.
If, in the meantime, there is an unfavourable move in relative exchange rates, the Sterling cost of the purchase could be pushed significantly higher if the Euro strengthens.
By taking out a currency forward contract, the purchaser can lock-in the exchange rate at the point when the contract is signed. This action eliminates the element of risk as the purchaser has guaranteed that there will be no increase in the Sterling cost.
The same principal will also apply when overseas property is being sold. Again, there will be a delay between the time a selling price is agreed and the actual transaction taking place.
If Sterling rose strongly in the interim period, the UK value of Euro proceeds would fall sharply. By taking out a forward contract, this element of risk is eliminated with the Sterling value guaranteed.
The Cost in GBP of Buying a €200,000 Property Over the Years
By using a theoretical example, we can see the impact of currency exchange fluctuations over time and the impact this has when budgeting for an overseas purchase. Forward contracts are one way to secure the exchange rate when they are favourable – the rate may move for or against you after the forward contract has been booked but forward contracts provide certainty around the rate achieved, providing peace of mind and allowing for accurate budgeting to take place.
|Date*||Euros||Cost in GBP|
*Rates taken are interbank exchange rates on the 1st Jan of each year. Source: Oanda
As seen with the example above, there are some years where booking a forward contract would have ensured a lower cost was secured in GBP when compared to the following year. In other years, it would have proved better to wait. The range in cost is quite significant – depending on the date the FX deal was booked, a €200,000 property could have cost anywhere from £167,928 to £179,762. By speaking with a specialist FX broker that provides currency forward contracts, and has a dedicated team of FX currency traders, customers can get a better feel for when to trade and with what type of solution. Whilst brokers aren’t able to provide direct advice, it might simply be that they inform you that the GBPEUR rate in Jan 2022 has moved to one of its most favourable points in the last five years for individuals looking to buy euro with sterling.
When to Use Currency Forwards?
The use of a forward contract is particularly useful when a period of transaction uncertainty traverses a major economic or political event.
The 2016 UK referendum on EU membership was a clear example of such an event. If a UK buyer of overseas property signed a contract just before the referendum, but the funds were not deliverable until after the referendum, there was a very clear and substantial currency risk.
Important Tool for companies
As well as individuals, forward contracts are extremely important for companies. Indeed, over the medium term, the impact is likely to be greater for business users.
Let’s look at a forward contract example for business… a company makes a substantial investment by purchasing overseas machinery, there will be a delay between the contract being signed and the equipment being delivered and paid for. If, in the meantime, there is an adverse move in exchange rates, the final cost of the equipment could be much higher than the budgeted amount. In order to avoid this situation the firm could have booked a forward currency contract.
Another forward contract example could see businesses buy currency forwards to use as an extremely important tool for on-going receivables and payments. If a British company has a substantial revenue stream in dollars, the use of a forward contract locks in the receivable amount in Sterling terms and protects a company against adverse movements which could wipe-out profit margins.
A company which has an on-going commitment to buying imported goods or raw materials, can also buy a currency forward to gain protection and guarantee that there will not be a sharp rise in the Sterling cost of imports. Fixing a forward exchange rate can be an essential tool for on-going cost control and margin protection.
Please note – in these scenarios, forward exchange contracts are far from being your only option! Businesses can also use FX currency options to hedge currency risk and speculate on the outcome of such events.
Speculative Tool for Some Banks
On April 6, 2021, Bloomberg reported that some Indian banks made a profit of up to a billion dollars on a single arbitrage trade. These banks were capitalising on the fact that regulatory changes increased their exposure limits, allowing them to take advantage of the unusual spread in the USD-INR exchange rate.
It’s unlikely individuals or SMEs will be able to use forward contracts as a speculative tool, and in fact, the forward contract providers reviewed in this section will not process forward contracts for purely speculative purposes only – clients will need to be able to prove it is for a genuine purpose, such as the purchase/supply of goods and services.
Making a Risk Assessment
Both companies and individuals may show some caution in the use of a forward contract if they believe the exchange rate will move in their favour in the future, but there will be occasions when the situation is compelling. If Sterling is extremely strong against a certain currency, there will be a much more compelling case for taking out a forward contract if overseas payments need to be made in the future. In these circumstances, there could be a risk of heavy losses if no protective measures are taken.
Similarly, there will be a strong case for taking out a currency forward contract if there is an income flow in an overseas currency and Sterling is very weak from a historical perspective.
For example, any Sterling move towards parity against the dollar or Euro would be extremely attractive based on rates which have prevailed over the past 30 years.
It’s important to note, however, that rates could move for or against you after a forward contract has been booked – FX rates are constantly moving at every second of the day.
List of All Companies we Have Reviewed who Offer FX Forward Contracts
Below you can find a finite list of all the companies we have covered and provide access to forward contracts for private and corporate clients:
- Currencies Direct Review
- World First Money Transfer Review
- TorFx Review
- Moneycorp Review
- Currency Solutions Review
- Global Reach Review
- OFX Money Transfer Review
- Kantox Money Transfer Review
- Key Currency Money Transfer Review
- Privalgo Money Transfer Review
- Smart Currency Exchange Review
- PureFX Money Transfer Review
- Currencies.co.uk Money Transfer Review
- XE Money Transfer Review (XE.COM)
- Voltrex FX (VFX) Money Transfer Review
- EasyFX Money Transfer Review
- Halo Financial Money Transfer Review
- Afex Money Transfer Review
- AxiaFX Money Transfer Review
- SendFX Review
- Transfermate Money Transfer Review
- Frontierpay Money Transfer Review
- FinGlobal Forex Review