What is a currency forward contract?

A major concern for people sending money abroad is the risk of losing money due to fluctuating exchange rates. Currency forward contracts come into play here and are the unsung hero in helping to mitigate this risk, by locking in a specific exchange rate for future transactions.

What is a Currency Forward Contract? 

A currency forward contract is an agreement that allows you to lock in a current exchange rate for a future transaction, up to two years ahead. This can be very helpful when transferring large sums of money internationally, as it protects you from potential losses due to changes in exchange rates. This article explains how they work and how to use them to help protect your future transfers. 

How do Currency Forward Contracts work? 

By locking in an exchange rate today for a transaction that will happen in the future, you can make clear budget plans without worrying about market movements. For example, if you're buying a property abroad, a currency forward contract lets you fix the price based on the current exchange rate, so you won’t be affected if the rate becomes less favourable later.

When should you use a Currency Forward Contract?

Did you know that in 2021, an estimated $13.5 billion (£10.8 billion) was transferred in and out of the UK.  Forward contracts are useful for many types of significant transactions, such as:

• Buying property overseas
• Maintaining property abroad
• Moving savings when relocating to another country
• Paying for overseas weddings
• Transferring inheritance funds
• Managing overseas income
• Receiving dividends from international stocks 

The impact of currency fluctuations

With large sums of money, even a small change in exchange rates can have a big impact. For instance, in 2023, the value of the pound against the euro varied between €1.1775 and €1.1135. For a €750,000 property, this could mean a difference of over £36,000, which could push the purchase out of your budget or cost you much more than expected. Locking in a rate with a forward contract can help you avoid these surprises and stick to your budget. 

Pros and Cons of Currency Forward Contracts

Pros:

• Protects you from losses if exchange rates move against you.

• Provides certainty for large purchases or investments.

• Helps you plan and predict your cash flow and budget.

Cons:

• You won't benefit if exchange rates move in your favour after locking in the rate.

• Creating a forward contract involves a legally binding agreement.

• Some people may prefer to take the risk and watch the market for better rates.

Forward vs. Current Exchange Rates

The current exchange rate is the price of one currency in terms of another at any given moment. A forward exchange rate is a fixed rate agreed upon now for a transaction in the future, adjusted for interest rate differences between the two currencies.

Forward Contracts vs. Futures Contracts

Both forward and futures contracts help manage currency risk, but they are different:

Forward Contracts: Private agreements tailored to specific needs, usually for straightforward asset purchases like property.

Futures Contracts: Standardised agreements traded on exchanges, often used by speculators betting on price changes.

Is a Forward Contract right for you?

A forward contract can protect you from losses, but you might miss out on favourable rate changes. If you prefer to take advantage of potential opportunities, other tools, like market orders, might be better suited to your needs.

Where can you get a Currency Forward Contract?

Foreign exchange specialists like Caxton offer forward contracts for future international payments, whether it's a single large payment or several payments over time. While market fluctuations are inevitable, a forward contract helps you manage the risk and keep your budget on track.

If you’re looking to make a personal international payment and would like to discuss how Caxton can help you get more for your money, get in touch with our specialists today. Book a call here.