This beginner’s guide will help you understand the concept behind Forward Currency Contracts, we explain the pricing methodology which determines your forward currency rates and we will direct you to our best choices to buy currency forwards 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.
Forward Exchange Contracts: Currency Forwards 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 you want to make the transfer. 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 FX 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.
- Currency forwards are offered by banks in particular cases (usually not to private clients), and readily available by international money transfer companies.
Best FX Forward Contract Service Providers
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:
- Min Transfer: £/€/$100
- Currencies Supported: 39
- Offices : UK, EU, USA, India, and South Africa.
- Our Rating : 97.8%
- Serving Clients Since 1996
94% Positive Client Reviews
Spot, Forward, Market Orders, Currency Options and Treasury Management.
- Min Transfer: £/€/ 1,000
- Currencies Supported: 138
- Offices : UK, Cyprus, and South Africa.
- Our Rating : 90.6%
- Easy Sign Up Process
Friendly, Welcoming Service
Forward Contracts, Limit Orders, and a Wide Array of Options
- Min Transfer: £/€ 1,000
- Currencies Supported: 121
- Our Rating : 95.4%
- 8bn in Annual Turnover
0.15% to 0.5% in FX Margins
Forward and Limit Options Available
Currency Forward Exchange 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 Future 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 interest rate differentials between the two currencies involved and the third is the time until the contract matures.
If the forward contract differed from this relationship, there would be an important 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 direction. This is not the case, however, as the forward price is a purely mechanical function of interest rate differentials, the time to duration 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 options markets 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, an 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 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.
Big events in focus
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.
By taking out a forward contract, this risk could have been eliminated. In the event, this would have been an extremely wise move given that the Sterling exchange rate fell very sharply following the referendum vote to leave the EU. An unhedged position would have exposed the buyer to an additional cost of over 15% in Sterling terms in less than a month.
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… a company makes a substantial investment by purchasing overseas machinery, there will be an important 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 you 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 currency forwards 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! you can use FX currency options to hedge your risks and speculate on the outcome of such events.
Making a risk assessment
Both companies and individuals may show some caution in the use of forward currency rates, but there will be occasions when valuations are 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 will be an important 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 an 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.
List of all companies we have reviewed who offer FX Forward Contracts
Below you can find a finite list of all the companies we covered and give access to currency forwards 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