Currency Forwards

Foreign Exchange Forward prices are the rates that include the interest rate differential between two currencies up to forward date. Interest rate differential between two currencies are called swap points and usually it is decimal points. Forward Rates=Spot Rate + Swap Points up to forward Date Forward rate is not a determined or locked price up to expiry date. They change on daily basis and they are more or lees a mirror of future prices.

They approach and become spot rate on the expiry date. These allow you to lock in a rate immediately but without having to pay for them until a future date. They are calculated by using the current exchange rate for the currency pair, the interest rates for the two currencies along with the length (date the contract is due) of the contract. They value the current exchange rate for the future date rather than trying to estimate where the market is heading.

Forward contracts will usually involve a deposit which allows you the luxury of being able to utilize the majority of your capital until the end of the forward contract. They also reduce your market risk by locking in a rate now even though the actual transaction is not taking place until a later date. This allows you to cost your purchases today and in doing so, effectively lock in your profits. Example Many of our customers who import goods and have to pay in foreign currency are concerned that adverse exchange rate movements will increase the amount of local currency they will have to pay when they convert to foreign funds. This risk can be managed using forward contracts.

A forward contract is a binding obligation that allows you to buy or sell a specified amount of foreign currency at a forward exchange rate for settlement at a specified future date - it's a kind of "agree now - exchange later" contract. The forward contract affectively "locks-in" the foreign exchange rate for a future date eliminating the effect that fluctuations have on your final outcome.

XYZ Ltd plans to import goods from the United Kingdom, with payment of 100,000 GBP Dollars to be made in 3 months time. If they were to put through a spot transaction at today's exchange rate of 0.6700* they would only have to pay EURO149,000.If the exchange rate falls 10% between today and when they convert their funds, to .6030 then they would have to pay EURO 165,000.XYZ Ltd decides they do not want to take this risk and decide they would prefer to 'lock in' a rate today that will be used for the transfer in 3 months.

They do this by booking a forward contract with WPP at 0.6700, this is binding on both parties. XYZ Ltd must give WPP Inc. a deposit of 5% to ensure the performance of the deposit. Just before the 3 months passes, XYZ Ltd remits the EURO149,000 (less the 5% already paid) to WPP and then WPP pays the GBP$100,000 to XYZ Ltd's suppliers account in England. Once the forward is booked it is binding.

This means that in the above example XYZ Ltd could not benefit from any increase in the value of the Euro, if that occurred. It also means that if XYZ Ltd was unable to complete the transaction by paying WPP the expected Euros the contract would be closed out', and any loss that occurred would need to be paid to WPP by XYZ Ltd (normally out of the 5% deposit).