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Chapter 10

Forward contracts

4.1 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.

4.2 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 sometimes quoted as an adjustment to the spot rate:

– add a discount

– subtract a premium.

4.3 Advantages and disadvantages

ADVANTAGES DISADVANTAGES

 Simple  Contractual commitment

 Low transaction costs  Lose upside potential

 Fix the exchange rate  Forward markets banned in some
countries – e.g. China, Russia
 OTC, so tailored

Illustrations and further practice

Now try TYU 1 in Chapter 10

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