Skip to content
English
Gå til kompasbank.dk
  • There are no suggestions because the search field is empty.

What is an FX Forward?

A foreign exchange contract (FX Forward) is a agreement between two parties to buy or sell a specific currency at a predetermined rate on a future date. It ensures that you have complete visibility into how your future inflows and outflows will affect your business – regardless of market movements. The price of the agreement is determined based on the spot exchange rate, the interest rate differential between the two currencies, and the contract’s duration, which is mutually agreed upon by the buyer and the seller.

A forward contract aims to lock in the exchange rate between two currencies at a specified future date, thereby reducing currency risk. This can be relevant, for example, if a company is contractually obligated to pay a fixed amount for a future delivery of goods in a foreign currency and wishes to secure the exchange rate in advance. By entering into a foreign exchange forward contract, the company can protect itself against fluctuations in the exchange rate, such as when a payment in a foreign currency is due in three months. Still, the company wants to know the exact price of Danish Kroner today.

How does it work?

Challenge
A Danish company has purchased machinery from a U.S. supplier for 100,000 USD. The payment is due in three months, but the company wants to avoid the risk of the dollar appreciating, which would make the purchase more expensive in Danish kroner.
Solution
The company contacts its bank and enters into a forward contract. The bank offers a fixed exchange rate of 6.80 DKK/USD for three months.
Result
Regardless of how the exchange rate develops, the company will pay exactly 680,000 DKK (100,000 × 6.80) at maturity.

  • If the rate rises to 7.00, the company saves 20,000 DKK.

  • If the rate falls to 6.60, the company could have paid less, but it has avoided a potential additional expense.

This agreement provides the company with cost predictability and protects it against exchange rate risk.

Advantages of FX Forwards

Protection against exchange rate risk (hedging): Locks in an exchange rate for a future transaction, thereby reducing uncertainty.

Liquidity certainty: Forward contracts help companies manage budgets and forecast expenses more accurately.

Flexible terms: Agreements can be tailored to specific amounts, currencies, and settlement dates to suit the company’s needs.

Disadvantages of FX Forwards

The rate is locked in: Once the agreement is made, the exchange rate is fixed. This means the company cannot benefit from potentially favorable market movements. While forward contracts offer predictability, they may pay more than the prevailing market rate at settlement.

Complexity: A forward exchange contract requires a solid understanding of the currency market and may involve more administrative effort than spot transactions.

If you want to learn more about foreign exchange contracts and gain insight into how we can help your business develop an effective currency policy and manage exchange rate risks with the market’s most flexible and competitive solution, you can book a meeting with one of our currency experts here.