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10
Nov

What is a Flexible Forward

A flexible forward is a type of forward contract used to hedge against the volatility generated by foreign exchange.
Characteristics of the flexible forward

 

Flexible forwards differ from a standard currency forward contract in that the purchaser can settle at any time up to the maturity date of the flexible forward contract. They may also settle various amounts from the total notional amount at various dates up to contract maturity, as long as that by the contract maturity date the full amount has been exchanged.

If settled before maturity, or, if various partial settlements are concluded, the exchange rate remains the same as it would at maturity date – the exchange rate locked in at the beginning of the contract.

Flexible forwards offer more diversity than standard forwards contracts, which only offer one sole date in the future on which the amount must be exchanged.

Companies use flexible forward contracts to hedge against foreign exchange volatility risk usually if they expect to need to make a series of payments.

For instance, a company may wish to purchase a flexible forward if they pay the salaries of employees in a foreign country. Another common corporate need is to pay foreign suppliers on a periodic basis.

Flexible forward contracts come with some disadvantages. If the spot rate on the forward contract settlement date is much different than the forward rate, the forward contract purchaser could stand to pay a lot more for the currency exchange than if they exchanged at the spot rate. Furthermore, a default on the part of the forward contract purchaser puts the contract issuer – normally a bank, broker or foreign exchange company – at financial risk.

Just like closed forward contracts, flexible forwards are unregulated, and parties that enter into forward contract agreements are normally extremely careful when choosing a counterparty. However, the threat of counterparty default is always there.

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