When should you use a forward contract?

Maybe you've heard of forward contracts, but you're not sure if you need one. Here's our guide to the best times to use a forward contract.

Xe Consumer

December 22, 20206 min read

Using a forward contract to send money overseas

If you’ve ever sent money overseas or checked the rates, you’ll know that in the world of foreign exchange, the rates can be volatile. Sometimes, the rates are higher and in your favor. Other times, the rates plunge so low that you hesitate to send a transfer even when you’re required to.  And with the currency markets constantly being in motion, just a few hours could make a difference of hundreds (or thousands) of dollars.

However, you can easily take advantage of favorable foreign exchange rates available today by locking them in to make a future transfer, even when the rates have fallen in the future. How is that possible and how does it work? 

It's called a forward contract and we are going to explain exactly how it works and how you can benefit from it.

What is a forward contract?

In a forward contract, you’re making an agreement to transfer:

  • A predetermined amount of a certain currency

  • To another predetermined currency

  • At a predetermined date

  • At a locked in currency exchange rate.

To complete a forward contract, all you have to do is decide how much you want to transfer, and when you want to make the transfer, lock in the current foreign exchange rate, and your transfer will be sent on that date.

So, if the rates are in your favor but you aren’t planning on making a payment or purchase just yet, you can still take advantage of the favorable rate without having to make your full transfer.

We like to think of forward contracts as the buy now, pay later option. You’ll pay a small deposit now, but you won’t make the bulk of your payment until your set transfer date.

When you’re transacting a larger sum of money, just a small fraction such as a 1% fluctuation of the exchange rate or even less, can have a substantial impact on the amount of currency you can purchase and transfer.

Even more, with a forward contract, you can plan your budget accordingly because you can figure out the precise amount of money that will leave your account at a certain period and the amount in foreign currency that you can transfer.

When should you use a forward contract?

While you can use a forward contract anytime you want depending on your specific needs, it is mostly useful for certain transactions such as:

  • Overseas property purchase

  • Payment of school fees abroad

  • Overseas property maintenance

  • Regular or phased payment overtime

  • Overseas wedding

  • A dream holiday

How do forward contracts work?

A forward contract refers to a foreign exchange agreement to purchase a precise currency by selling another on a stipulated date within a predetermined period at a price you agreed on right now usually described as the forward rate.

More simply, this means the forward rate is the exchange rate you agreed on today which will be used to transfer your currency later at the date or period you agreed on. The forward rate can be calculated depending on the spot rate and changed to consider other factors such as the period until the transfer and the precise currency you intend to exchange.

However, the forward rate you made a decision on today isn’t required to be the same as the rate on the day the exchange actually takes place. This is why a forward contract is initiated at a locked in exchange rate.

For example, if the usual exchange rate of the U.S. dollar to your home country’s currency is 150 and as a result of market forces, the rate increases to 180 today. You may decide to send a forward contract of $500 USD at a locked in currency exchange rate of 180 today. But you want the money to be transferred at the end of the month.

Your $500 will be transferred at the end of the month at an exchange rate of 180 to $1 even if the normal exchange rate at the market is back to $1 to 150.

What are the benefits of a forward contract?

Unaffected by currency fluctuations

Foreign exchange rates are hardly predictable. They are affected by several factors which explains why they are constantly fluctuating. But with a forward contract, you can easily lock in a favorable exchange rate now and plan ahead accordingly.

Forward contracts provide the certainty you need to trade or do business in a volatile foreign exchange market. You can easily send money overseas for any reason without worrying about a sudden change in exchange rate that may ruin your entire plan.

Hedging against risk

If risk management is a major concern for any of your foreign exchange or transactions, a forward contract is a viable solution. You can easily use a forward contract to hedge risks related to foreign exchange. If the market experiences a sudden plunge, your locked in exchange rate will protect your fund against potential losses.

Perfect for any amount

You have the absolute freedom to set the precise amount of money you want to lock in for a forward contract. This gives you the freedom to manage your fund just the way you want and set any desired date for your forward contract transaction.  

Planning your budget better

A forward contract gives you the opportunity to plan your budget better. If you’re planning to send a larger sum of money for any reason, a fraction of a percentage point change on the exchange rate can cause a significant difference.

For example, if you need a foreign exchange to place a key order from a supplier based in a foreign country, or you have a long-term contract overseas, you can easily manage those costs within a definite budget through a forward contract.

Take advantage of attractive exchange rate

If the current exchange rates are attractive and seem like a very good one for your or your business, a forward contract is an easy way to take advantage of it now.

You can easily lock in the rate, even if you’re not ready to make any transactions now. You can set the transfer period to match your desired date to keep your funds predictable while making payment, buying or sending money overseas.

Price protection

Since a forward contract makes it easy for you to fix a price right away for a future foreign exchange, it’s an easy and effective method of protecting the foreign exchange price of whatever you intend to buy in the future. 

For example, if you’re going on holiday abroad, you can lock in a forward contract using a good exchange rate today to  pay for accommodation in the future in your desired country. 

Where can you get a currency forward contract?

You can get a currency forward contract on Xe. We offer foreign exchange in over 130 countries worldwide in all the known currencies. Whether you’re paying for your child studies, buying a residential property, or planning a holiday trip abroad, the possibility of what you can do with a forward contract is endless.

Interested in setting one up? Give us a call to set up your forward contract and schedule your payment.