Currency Forward Hedge Traders Cash from Market Risks

Currency forward is a one of the products offered by foreign exchange companies. Currency forward is an agreement done between two parties keeping forex company as a mediator and authority. Here the exchange rate of future delivery or transaction is prefixed. The prefixed rate is known as forward exchange rate. Companies do not choose currency forward with an intention to make money but they want to protect their transaction from the uncertainty of forex market. When businesses have to transfer large amount abroad, they seek the safety of fund. Also, every business transaction needs to be certain in its value. Forex rates are highly volatile. If the transaction is going to be held after few months of the deal, the buyer will not be able to calculate exact cost. Thus, signing currency forward contract they know the exact payment they have to make.

Forward exchange rates offered by various foreign exchange services may vary thus traders or investors must research well and compare the rates. None of the parties can quit the contract before executing it. The time to conduct transaction is locked in the agreement which can be any period  within a  year. There are businesses who often make transactions in millions and billions. For such companies or financial institutes, even a decimal fraction change in exchange rate makes a difference of lacs and millions. When businesses opt for forward exchange rates, they close the doors of possibilities for positive market movements and gains. This hedging service doesn't come for free, foreign exchange firms or brokers do charge some interest amount based on the period you have locked for fixed exchange rate and spot(current) rate of that particular currencies in market. Shopping around for the best forward exchange rate can help you save a bit of your hard earned cash.

Why Traders need FX Forward Contract?

FX forward contract is an agreement between two parties involved in foreign exchange transaction. Both the parties with the help of forex specialist fixed the exchange rate for a future transaction. This transaction will be held on a specific date of future and the amount is also known. The rates fixed in this type of agreement are known as forward exchange rates. Once both the parties sign FX forward contract, none of them can quit the contract before executing it.

Traders in forex choose FX forward contract to hedge their transaction from the unfavorable movement of forex. However, it is impossible to predict exchange rates of any currency but traders are mitigating the possible chances of negative forex movements at the specific future date. Many reputed forex firms offer the scheme or product of FX forward contract to protect their hard eared money. It may also possible that while executing transaction on a future date, market reach in a favorable condition and you may loss a good opportunity to make profit. The time to execute contract varies based on the clients requirements. However, it is within 1 year. It is a fact that every luxury comes for money and same thing applies to forward contract as well. Forex specialist firms charge some interest rates based on the time decided to execute transaction. There is a standard formula to calculate the interest amount in a forward contract. Parties can fix 1month, 2month, 3 months or any period within 1 year to complete the order. This time span in forex terminology is also known as delivery time or maturity time.

There are businesses who make large transactions overseas on a regular basis. For them security of their funds is the first priority. They trade in forex as a means to transfer money abroad, not with an aim to earn profit. Forward rates are fixed on basis of spot rates or current rates of the market. If company X from US is making transaction with the company Y in UK and finds that the current market condition is positive for them, they can lock the spot rates choosing forward contract scheme.

FX Forward Contract to Protect your Hard Earned Cash

FX forward contract is in introduced in forex market with the primary purpose of hedging foreign currency investment of the global clients. FX forward contract is an agreement between two parties where in the rate for future delivery of transaction is decided based on the current market situation. This locked exchange rate is known as “forward exchange rate”. There are mainly two types of forward exchange rates: one is premium and another is discount forward exchange rates.

Before understanding forward exchange rate, it is important to know one more terminology-spot rate. Spot rate is the current market rate for particular currency. When FX forward contract is offering forward rate which is higher than spot rate of that currency, it is known as premium and in exactly reverse condition when forward rate is lower than the spot rate, it is known as discount. To understand this premium and discount FX forward contract, let's consider the following example:

The quotes for currency pair GBP/USD are as below :
GBP/USD spot :: 1.95/97
GBP/USD 3 months :: 1.96/99

In above example, you can see that the spot rate of GBP/USD is 1.95 and after 3 months banks can offer the forward rate of 1.96 means GBP would be more expensive at that time. Thus, GBP is premium against USD.

There is one more terminology which is related to FX forward contract rate and spot rate. It is “swap points”. Swap point is the difference between the spot rate and forward rate. Let's calculate the swap points for above example:

1.96-1.95/1.99-1.97=1/2(swap points low/high)

If we know the spot rate and premium or discount then we can calculate FX forward rate:

Like in example discussed above spot rate was 1.95 and if forward premium is 2 for 3 months then the forward exchange rate offered by bank or forex firm will be 1.97.

Safeguard your International Payment with Currency Forward

One method to protect your international payment is currency forward contract. It is a product of Forex specialist firms which binds two parties (Seller and buyer) in an agreement. Now what is this agreement for? As per this agreement or contract, the buyer will make payment on and before the fixed date and at the fixed exchange rate. Neither the seller nor the buyer can exit from currency forward contract. It is a best way to protecting your valuable fund when you are firm regarding your future deal.  The rate which is locked in this contract is known as forward exchange rate. In case, you are buying some material from the US supplier and you know that you will be making the payment after 3 months. If you can see that current market condition is notoriously volatile and in future it may get worst. You can't take risk with your fund. In such case, you can opt for currency forward contract.

Big businesses make large size trading thus for them security of fund is utmost priority. The larger the size of transaction, the more your fund is vulnerable to risk. Forward exchange rates protect your transaction from any ups and downs in Forex. Also, one need not to remain uncertain about his/her total budget. However, if the market turn to your favorite condition, you may loss some profit making opportunity. In case, your overseas transaction is not needed, you can't exit from the contract. Not only private Forex specialist firms but banks can also offer forward exchange rates. Forex firms can provide customized solution which meets your requirements in affordable cost. If you have bought any property abroad and want pay the seller in installment then exchange rate will different for every installment. The varying exchange rate can add unnecessary cost to your total budget. Forex specialist firm can provide you tailored solution wherein you can fixed the rate for all installment. 

Introduction to Currency Forward Contract

What is currency forward?

It is a contract done between two parties wherein they lock specific rate (known as forward exchange rate) for a specific future date and buy or sell currency or asset. Currency forward contract needs to be followed by both the parties in all circumstance, no one can quit from it any time.

At the time of making currency forward contract, both the parties decide the contract expiry date which is generally within 1 year. Before this contract expiry date, they can complete the transaction at anytime.

Why to choose forward exchange rates?

Today, businesses are not bound to target market within their own country. The global boundaries are shrinking and world is becoming a global village. Many businesses have offices abroad or hire goods and services from foreign country. When you buy or sell any product or service from overseas country, you must exchange our currency with the foreign currency. Now, let's take a simple example to understand why they opt for forward exchange rates (often known as “forward rates”).  X company from UK want to import some manufacturing parts of engine from Y company of US. Y company has already informed X company that they would be able to export goods after 3 month. Today, GBP is in good condition in comparison to USD thus spot exchange rate is 1.9 but it seems that recently took place London riots will make gradual impact and currency will become a bit weaker. Forex market analysts has made predicament that exchange rate of GBP and USD will fall down in next three months. If they wait for three month and complete the transaction they will make a loss of 2 to 3% which can be in large if the total transaction size is big.

Currency forward contract is an option where you can hedge your transaction from the future negative violation of sterling. You can make an agreement for 3 months and lock one rate on which you will import the goods from Y company of US. On the contrary, if Chinese economy is not stable and a retail investor has invested in American dollars, it is the best option to hedge fund via forward rates.

Forward Exchange Rates Provide Total Currency Hedging

Investor words defines forward exchange rates as : “The exchange rate set today for a foreign currency transaction with payment or delivery at some future date.” Hence, it is rate that is decided at this moment but traders can pay it on stipulated future date at stipulated time. In a direct contrast to these rates, there are spot rates. In fact, spot rates are the rates with which transactions on foreign exchange market begins. True to their names, spot rates are the rates that are for immediate transactions.

Now, when you are sure that at a particular time and date, you need to pay certain fixed amount to buy a currency, you are in peace. This is called complete currency hedging. As everyone knows, foreign exchange market is extremely volatile and therefore, it is highly risky to trade on this market which requires day to day check. Businesses which are into international transactions often need to be vigilant about these rates and in order to avoid losses, they often have to indulge in forward exchange rates. 

If you have opted for forward exchange rates, it automatically assures you sound sleep and you will get your money as agreed upon between you and the financial services provider. In this way, it can be said that forward rates are the best solution for currency hedging. If forward contract is the one for the businesses, spot rates are the most common type of rates because it is the real time currency conversion. Once the rate is fixed with which one is going to buy the currency, it will take almost two days to complete the task. In this way, spot rates do provide a bit currency hedge, but there are no guarantees of total currency hedging in spot rates as compared to forward exchange rates.

Hedging Risk Using Forward Exchange Rates

Foreign exchange (Forex or FX) is the only market on planet where brokers, banks, big financial institutes, retail investors swap currencies in staggering volume on daily basis. Forex is highly volatile market. The currencies are changed in value at every second thus it is very difficult to keep a track on currency value. If you have invested large amount in forex currency hedging is very important aspect to protect your hard earned money from the negative fluctuation of currencies. Forex companies offer forward exchange rates and spot rates to hedge your transaction.

Exchange rate of two currencies or a pair of currency is governed by so many factors like interest rates, economical and political stability,etc. A minor change in any of this governing factor can change the exchange rate. If you have invested in more than one currency pair then also a negative movement of one pair can diminish the positive movement of others. If this is the first time you are investing in forex for business growth, you ought to know about forward exchange rates and spot rates. Spot rate should be chosen when you can finish the order within 2 days thus this is widely used by regular traders.

Using forward exchange rates or forward rates, the service provider forex company create a legal document where in two parties seller and buyer fix the rate and date of future transaction based on the current market. The period is decided on the agreement of the forex company which can be 1month, 2month,3months,1 year or anything. Based on the amount involved and the period decided to complete the order, interest is charged by forex. However, for businesses the priority is currency hedging not the profit from their investment thus paying nominal interest on forward rate is best solution for businesses. Choosing this option businesses are reducing the exposure of invested money from negative as well as positive market movement.

Forward Exchange Rates Minimize Exchange Rate Risk

What do you understand by the term exchange rate risk? It is the risk that a business' operations or an investment's value will be affected by changes in the exchange rates. Let's see one example to see how negative movement in exchange rates can be risky for traders and how spot rates and forward exchange rates minimize this risk factor.

Suppose, you have purchased American dollar by exchanging British pound or sterling. Now, the price of American dollars starts decreasing suddenly so you will not gain any profit if you sell them instead you will count a big loss. Now, you might be thinking that why we are selling the currency when the market is down? Can't we wait till the market rise again? Well, it is not always possible in the real life scenario.If you have purchased a home abroad and you have make a deal that you will pay the seller after 2 month. The time when you make this deal the rate was GBP/USD=1.054 but it falls to 20% when you actually made the payment.

Exchange rates changes at every second and impacts on retail as well as businesses who make international payments. Many forex companies are offering currency hedging service to minimize investment risk. Forward exchange rates is the rate decided between the client and the company in current date for the future payment delivery. Spot rates are also offered for currency hedging but in this service you need to complete the payment within 2 days only. Choosing forward exchange rates, you need not to worry for any negative movement in the exchange rate but at the same time you must be ready to leave profits in case the market moves in positive direction. Once the rate is locked, you are obeyed to execute your payment with this decided rate only. You will be given a specific duration like 2 month, 6month or may be 1 year to make the payment.

Forward Exchange Rates - Effective Risk Management for your Business

If you are new to forex market, you must be wondering  what are spot rates and future or forward exchange rates? Whenever currency conversion takes place such terminologies are often used. What do these terminologies mean? Spot rates are the rate of currency exchange at the moment, and fluctuate quite a bit over the course of a day. Whereas, forward exchange rates are rates that are quoted today for delivery and payment on some specified date in the future. No currencies change hands on the date the contract is signed for forward exchange transactions. Forward exchange rates and spot rates are actually two methods of trading currency in forex market.

Let's understand Forward exchange rates (also called forward rates) method. In Forward rate contract, two parties made an agreement and fix the currency exchange rate for the transaction which going to be held in the future. Forward rates provide 100% currency hedging for your earned money. The forex company has a team of market analysts who research on the all the factors governing currency rates of the different countries. The major six factors are inflation, interest rates, speculation, change in competitiveness, relative strength of other currencies and balance of payment.

Foreign exchange companies continuously monitor all these factors and design a model which can predict the currency rates of future. Most of the foreign exchange companies are in colloboration with the international banks. Thus they buy foreign currency in a large size at the fix rate. Even if the market foreign exchange rates gets fluctuated thenafter forex companies can still offer best deal for your business transaction. If you have signed a forward contract and locked a rate for the future transaction, you can complete your transaction at any time within the decided period in agreement. Business transactions involves large amount thus currency hedging is a key consideration for overseas money transfer.

Which is a Best Deal? Forward Exchange Rates or Spot Rates?

Use of correct strategy and proper money management techniques has delivered a great success to many businessmen who are involved in forex market. Businessmen who often buy or sell currency or assets take assistance of online forex company. With the help of such forex company, every businessman executes overseas transaction with currency hedging. The term “currency hedging” is quite familiar to those involved in forex market.

Currency hedging is a technique which reduces the risk involved any foreign exchange transaction. There are several options available in the market that provides currency hedging service up to various extent. First is forward contract, as per this service a person can lock the rate at which they will sell or buy currency on any date in the future. The agreement is done between the forex company and that person. The rate fixed by the dealer and an individual is widely known as forward exchange rate or forward rate. Forward exchange rates provide 100% currency hedging. As per forward contract service, a person can execute the order within the specified period which can be 1 month, 6 month or a year. The time span to execute payment is predefined between the dealer and an individual while making the agreement.

Another service which offers currency hedging is sport contract. However, sport contracts do not offer 100% currency hedging. A spot agreement means sale and purchase of foreign currency in a very small duration and with the current applicable rate. Forward exchange rates are spot rates of future. To trade with the spot rates, a person needs to analyze the currency fluctuation in market well in advance. Based on his research, a person can predict one rate and execute transaction in a very short duration. However, it may happen that sudden changes occur in the currency rates which can destroy the currency hedging service for your transaction and can put you in loss. It seems that because of the inadequate terms applicable in spot rates, traders are more attracted towards forward exchange rates.

There is one more reason why traders prefer forward exchange rates over spot rates is the time given for execution of payment. In property business, it is not possible to execute payment within 2 days of span.  Forward contract service is widely used by the corporate people who are involved in forex market.