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Currency risk management

Forward Contracts

5.1 Definition

A forward contract is a binding agreement to buy or sell a specific amount
of foreign currency at a given future date using an agreed forward rate.

5.2 Features and operation

 Forward contracts are a commitment, and as a result they have to be honoured
even if the rate in the contract is worse than the rate in the market.

 Forward contract rates are often quoted as an adjustment to the spot rate:

– add a discount ('add:dis')

– subtract a premium.

5.3 Advantages and disadvantages

ADVANT DISADVANTAGES

 Simple  Contractual commitment

 Low transaction costs  Lose upside potential

 Fix the exchange rate  Forward markets banned in some
countries – e.g. China, Russia,
 Tailored India, Brazil

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