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FX Forward

What is an FX Forward?

An FX Forward is a contractual agreement between the Client and the Bank, or a non-bank provider, to exchange a pair of currencies at a set rate on a future date. The pricing of the contract is determined by the exchange spot price, interest rate differentials between the two currencies and the length of the contract, which the Buyer and the Seller decide.

Objective

The purpose of an FX Forward is to lock in an exchange rate between two currencies at a future date to minimise currency risk. This might be done, for instance, if a company is contractually obliged to pay a set amount for the future delivery of goods in a foreign currency and wishes to lock in the rate.

How does it work?

A US business plans to sell €2 million of products to a European company and receive the revenue in 12 months. The US business is concerned that the dollar may strengthen against the euro and reduce the value of its exports. It enters into a FX Forward to sell €2 million in 12 months to lock in the rate at $1 = €0.90 and protect its income. If, a year later, the spot price of one dollar is €1.10, the company will benefit from the contract. If the dollar has dropped to €0.80, the company will lose out under the contract by receiving fewer dollars for the euros than it would have at the spot rate.

Advantages
  • Provides certainty to the Buyer regarding the cost of a future purchase
  • A FX Forward can be tailored to the exact requirements of the client
Disadvantages
  • Clients are bound to honour the contract and cannot benefit from advantageous movements in currency prices
  • Should the market move against the Client, Bank or Broker margin requirements may adversely impact the Borrower’s cash flow

FX Forward example:

 

Recent insights

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Finance Watch – October 2018
Ian MacFarlane Project Finance & Infrastructure October 2018
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South African Rating Relief
Lionel Kruger Project Finance & Infrastructure, Weekly bulletin October 2018

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