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Lock in a future exchange rate
The simplest way to remove currency uncertainty from a future cash flow. Two parties agree today to exchange one currency for another on a fixed date at a fixed rate, and both are obliged to go through with it whatever spot does in the meantime. The rate is not a forecast: it is today’s spot adjusted by the interest rate gap between the two currencies, because anything else would let someone borrow in one currency, lend in the other and pocket the difference risk-free.
Open in the app · FX · foundational
An FX forward is a customised OTC agreement to exchange two currencies at a fixed rate on a specified future date. Both currencies are actually delivered on that date, and neither side can walk away — that firm obligation is what separates a forward from an option.
Spot in most currency pairs settles two business days after the trade date. Anything dated beyond that spot date is a forward; USD/CAD is the main exception, settling one business day after trade.
The forward rate is the spot rate adjusted by forward points, which come from the interest rate differential between the two currencies. The currency with the higher interest rate trades at a forward discount — otherwise borrowing in one and lending in the other would be a free profit. Quote convention decides the direction of the adjustment: in EUR/USD the euro is the base currency and the dollar the quote currency, so the rate reads as dollars per euro, and when dollar rates sit above euro rates the forward rate is above spot.
Forward points are quoted in pips — the fourth decimal place in most pairs, but the second in yen pairs, where USD/JPY moves in units of 0.01.
Companies use forwards to lock in an exchange rate for future receivables or payables, removing uncertainty from currency moves. An importer with a known foreign-currency bill buys that currency forward; an exporter expecting foreign-currency revenue sells it forward. In both cases the domestic-currency value of the cash flow is fixed on the day the hedge is done, not on the day the money arrives.
Spot rate, forward points, value date and notional define the trade. The value date is the day the two currencies actually change hands. An outright forward is a single exchange on one date, while a window forward lets the company settle at any point across a range of dates.
A window forward is priced conservatively, because the dealer has to assume the client will pick whichever date in the window suits the client rather than the dealer.
A forward is a firm obligation, so if the underlying exposure disappears — an expected sale falls through — the company is left holding an unwanted currency position that can only be removed by trading out of it at the market rate, crystallising a gain or a loss. Locking the rate also gives up any benefit if spot moves favourably, and the contract carries counterparty risk until settlement.
The dollar pays more interest, so it is worth fewer euros forward and EUR/USD rises with tenor. The 107 points are that interest gap, not a view on the euro — and because a forward binds both ways, the company gives up the good outcome along with the bad one.
A UK importer paying dollar invoices ninety days after shipment uses forwards so the margin priced into the sale survives to the accounts, and an exporter selling into Europe does the mirror trade on its receivables. Fund managers run the same hedge at portfolio level, selling the currency of overseas holdings forward against the fund’s base currency and rolling the hedge as each contract matures.
The app adds a twelve-question bank for FX Forward, drawn differently every sitting, and a review queue for whatever you miss.
A subscription adds 3 further sections on FX Forward — Where forward points come from, Dates, and why they are half the trade, Rolling and pre-delivering — and 12 more questions to its bank.
Educational content only. Nothing here is financial advice, an offer to trade, or a recommendation to buy or sell any instrument.