Currency Forward

Karen See Forward? That makes no sense.

Oh...Siri just can’t pronounce things. She’s drunk.

A currency forward is a contract that locks a buyer into a binding contract to purchase currency at a date in the future. For the seller, it locks them into a binding contract to sell that currency in the future.

Currency forwards are hedging tools designed to reduce currency risk and help companies better stabilize their balance sheets in time of currency volatility. Unlike futures contracts, forward contracts don’t have a specific contract month or expiration date. Instead, they're customizable, and allow users to determine before signing onboard the exact time and date of delivery. Another important difference between currency forwards and currency futures is that they don’t trade on an exchange.

So...let’s assume a U.S. shoe company sells products abroad. They’ll receive a payment of one million euros in six months. That’s a lot of money and a lot of time before they get money for the products they’ve sent abroad. The exchange rate between the U.S. dollar and the euro could swing wildly at any time with those crazy kids running the economy out of Brussels.

Imagine that the exchange rate today is one euro for $1.15...but it falls to one euro for $1.08. That would represent a decline of $1.15 million to $1.08 million...which is a $70,000 loss due to currency risk.

So, to mitigate currency risk, they’ll lock in a currency forward that would get the company $1.15 for every euro. This ensures that, if the value of the currency were to fall, they’d protect themselves against the downward risk.

Now, keep in mind...these forwards have a bit of a zero-sum game to them. The person who's on the other side of the forward would have lost money, because the euro appreciated against the U.S. dollar in that example. So, not exactly a win-win.