Forward contracts explained

Forward Contracts Explained

A forward contract is the most widely used tool for hedging currency risk. It's a binding agreement to exchange a specific amount of currency at a predetermined rate on a future date.

How It Works

When you enter into a forward contract, you and your FX provider agree on three things:

The amount of foreign currency to be exchanged

The rate at which it will be exchanged

The date on which the exchange will take place

Once agreed, this rate is locked in, regardless of what happens in the market between now and the settlement date.

The hotel booking analogy: Imagine you're booking a hotel for a trip three months from now. You could wait and pay whatever the rate is when you arrive: maybe it's cheaper, maybe it's much more expensive during peak season. Or you could book now at a fixed price and know exactly what you'll pay. A forward contract works the same way.

Forward Points

The forward rate is not the same as the current spot rate. The difference is determined by "forward points," which reflect the interest rate differential between the two currencies.

If the currency you're buying has a higher interest rate than the currency you're selling, the forward rate will typically be less favourable than spot (and vice versa). This isn't a fee: it's a mathematical relationship driven by interest rate parity.

Your BLK.FX dealer explains the forward points and how they affect your rate.

Window Forwards

A standard forward contract requires settlement on a specific date. But what if you're not sure exactly when you'll need the funds?

A window forward gives you flexibility. Instead of a single settlement date, you have a window (typically anywhere from one week to several months) during which you can draw down the currency at the agreed rate.

Businesses use these for:

Businesses with approximate but not exact payment dates

Multiple smaller payments within a period

Contracts where delivery dates may shift

Window forwards can be arranged for periods up to 12 months.

Worked Example

A UK manufacturer needs to pay a US supplier $250,000 in three months. The current GBP/USD spot rate is 1.2600.

Without hedging: If GBP/USD drops to 1.2000 by payment date, the cost rises from £198,413 to £208,333, an increase of £9,920.

With a forward contract at 1.2580: The cost is locked at £198,728 regardless of market movements. Even if GBP/USD drops to 1.10 or rises to 1.40, the cost remains the same.

The forward rate of 1.2580 (slightly below spot of 1.2600) reflects the forward points, a tiny premium for three months of certainty.

When Businesses Use Forward Contracts

Forward contracts are commonly used by:

Businesses with known future payments in foreign currencies

Companies with fixed-margin contracts where cost certainty is essential

Anyone making a large one-off payment (property purchase, capital expenditure)

Importers with regular monthly or quarterly supplier payments

Key Considerations

Forward contracts are binding: the exchange has to be completed on the agreed date

Booking a forward typically requires a deposit (margin) of 3% to 5% of the contract value, held until settlement. A 500,000 USD forward typically means finding 15,000 to 25,000 USD up front. The exact level depends on the currencies, the tenor and the provider.

If the market moves in your favour, you won't benefit from the better rate, but that's the trade-off for certainty

Forward contracts can be arranged for periods from one week to 24 months

Key takeaway: A forward contract removes exchange rate uncertainty entirely. You know your cost today, and nothing the market does between now and settlement changes it.

FORWARD CONTRACTS EXPLAINED