What is a forward contract, and why hasn’t your bank mentioned it?
Locking in a future rate has a name: a forward contract. It’s a standard, decades-old tool, not an exotic one. So why does it rarely come up when you pay a foreign supplier through your bank? The answer says more about who’s selling it than about the tool itself.
The idea of getting today’s rate for a payment you’ll make later has a proper name. It’s a forward contract, which sounds like something from a trading floor, but the mechanics are ordinary, and businesses of all sizes use them regularly. It’s worth understanding what a forward is before deciding whether it fits how you work.
So what is it, in plain terms?
A forward contract is an agreement between you and a provider to exchange one currency for another, at a rate you both fix today, on an agreed upon date in the future. That’s the whole thing. You’re not borrowing, and you’re not taking a risk by betting on the market. You’re agreeing to the exchange rate now, for a transaction that completes later, exactly the same way you would agree on a price with a supplier for materials to be delivered next quarter.
Why have I never been offered one?
Most likely because you’ve been buying currency from a bank as you need it. You’re probably using a service built around instant payments, and the margin on those payments is where the bank makes its money. A forward doesn’t fit neatly in that box, and there’s less incentive for the bank to point you towards a tool that helps you plan around the rate rather than simply accept it on the day.
Is this only for big companies?
No way. What matters is the size of the payment, not the size of the company. If you have a known foreign cost of a few thousand dollars, for example, arriving at a known later date (also known as exposure), that is the situation in which a forward contract works best. Specialist FX providers offer them to businesses of all sizes.
What does it cost to set one up?
The rate itself carries the pricing, rather than a separate fee. A provider will usually ask for a modest deposit to secure the contract.
The next article in this series looks at exactly why the forward contract rate differs from today’s rate, because that difference is neither a charge nor a prediction.