This is a contract where two counterparts agree to transfer ownership of a predetermined asset for a predetermined price at a predetermined date in the future. On that future date, both the transfer of the asset and the payment for the asset will take place. Unlike an FX Option, the FX Forward is binding for both parties. Both parties have a right and an obligation. One party can not unilaterally decide not to “exercise” the FX Forward.
The FX Forward is often used by companies or other entities that wish to mitigate currency risk.
Example 1: Company NNN, based in the United States, knows that it will have a 1 million CAD bill to pay on May 30 next year. To mitigate currency risk, it enters into an FX Forward agreement with company OOO. According to the details of the FX Forward contract, OOO will transfer ownership of 1 million CAD to NNN on May 25 next year, and NNN will pay OOO 700,000 USD on May 25 next year.
Example 2: Company XYX, based in the United States, knows that it will receive a payment of 2 million CAD on September 1 this year. It is now January, an Company XYX would like to know for sure exactly how much USD they will get for 2 million CAD on September 1. Company XYX therefore enters into an FX Forward agreement with company ZZZ. According to the details of the FX Forward contract, XYX will transfer ownership of 2 million CAD to ZZZ on September 1 this year and ZZZ will pay XYX 750,000 USD on September 1 this year. Thanks to the FX Forward, XYX no longer have to worry about how much USD they will get for their 2 million CAD.
Not traded on exchanges
FX Forwards are usually tailor-made contracts catering to the specific needs of the two counterparts. FX Forwards can be traded, but the trade will be over-the-counter (OTC). At the time of writing, none of the major exchanges have developed standardized requirements for FX Forwards and FX Forwards are not exchange-traded. For more information about a standardized alternative to the FX Forward, see the section about Foreign Exchange Futures below.