What is a currency forward contract?

Businesswoman who got into a currency forward contract.

A currency forward contract is a written contract between two parties to buy or sell foreign currency at a fixed price and at a specified future date.

If you’re making an international money transfer, you’ll want to ensure you’re making the most of your money. Whether you’re investing in property overseas or supporting a loved one living abroad, you may wish to hedge foreign exchange rate risk. A currency forward contract* allows you to do this.

How does a currency forward contract work? 

By securing a prevailing exchange rate for up to two years, a currency forward contract can offer protection against upward or downward exchange-rate movements.

Fixing the exchange rate means you can make a clear budget plan. By knowing that each payment you make is bound by the agreed forward exchange rate, you can be certain that the payments remain within your budget.

For example, if you buy a property overseas, a ‘currency forward’ allows you to fix the property price based on the exchange rate at the time you saw it. By the time the sale is complete, the exchange rate may have fluctuated, but the price you pay is locked in by the currency forward. This could save you a lot of money, depending on how the market has moved.

When do you use a currency forward?

A currency forward contract is particularly useful for major purchases such as:

  • Overseas property purchase
  • Overseas property maintenance
  • Regular or phased payments over time
  • Overseas wedding
  • The holiday of a lifetime

This is because on larger sums of money, even a one per cent fluctuation of the exchange rate can have a significant impact on the amount of currency purchased. It also ensures that you can accurately plan a budget by knowing exactly how much sterling will be leaving your account and how much foreign currency will be delivered.

What is the difference between a forward exchange rate and the current exchange rate?

Forward exchange rates are based on the prevailing rate of currency exchange, but are adjusted for the interest rate differentials between the currencies involved. Both parties are contracted to the forward exchange rate agreed at the time of the contract, which will remain fixed until maturity.

What is the difference between a forward and a futures contract?

A forward contract is a private, customised arrangement. A futures contract is traded with standardised terms on an exchange such as the London Stock Exchange.

Forward contracts tend to be used by hedgers for less volatile, straightforward assets such as a property or a single expensive item. The arranged transaction and delivery is usually completed. 

Futures contracts are often used by speculators who bet on price changes on the asset. They often never actually reach delivery stage.

Pros and cons of a currency forward contract

Pros

A currency forward provides certainty in foreign exchange transactions – a big advantage to high net worth investors. Knowing exactly how much currency you will be buying or selling allows you to plan ahead and budget more effectively. If the market takes a dramatic dip, your fixed forward exchange rate will protect you from potential losses. 

Cons

Currency goes up as well as down. If the market moves in your favour after you have established the contract, you cannot benefit from the opportunity. Some prefer instead to take the risk and watch the market.

How do I know if a currency forward contract is right for me?

While a currency forward protects you from losses, you will miss out if the value of the currency improves. If you prefer to take advantage of potential opportunities as they arise, there are other tools available such as market orders which may be more suitable. 

Where can I get a currency forward contract?

We have partnered with the currency exchange specialist moneycorp to offer you the Telegraph International Money Transfer Service. Using the service allows you to establish a forward contract on an international money transfer, whether you are buying a holiday home, paying for a wedding abroad or funding your child’s studies in a foreign university. 

In the currency market, fluctuations are inevitable. However, a currency forward contract mitigates exchange rate risk and gives you stability through choppy waters. 

*A deposit may be required when using forward contracts

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The above article was created for Telegraph Financial Solutions, a member of Telegraph Media Group Ltd. For more information on Telegraph Financial Solutions click here.

TTT Moneycorp Limited is authorised by the Financial Conduct Authority under the Payment Service Regulations 2017 (reference number 308919) for the provision of payment services.

Information correct at date of publication.