Preloader Close
13
Nov

Standard Forward Contract

A forward contract is a basic type of currency hedge. It is an agreement for future purchase or sale of foreign currency at a fixed, set exchange rate completed at a previously established time in the future. The forward exchange rate is based on the spot rate, modified by so-called “forward points”.

 

These are determined by the duration of the period for which the forward contract has been arranged, and the difference in the interest rates of the traded currencies. With a fixed forward rate a company gains security and eliminates risks arising from future negative exchange rate trends. On the other hand, the company cannot profit from any positive trend for these exchange rates. For this reason it is appropriate to decide between insuring 100% of the trade or only a part of it.

There are no fees for completing a forward contract. Forwards can be set for a certain period (up to 1 year standard, or longer in individual cases). The number and amounts of such trades are unlimited. The trade becomes binding at the moment of completing the transaction.

Conditions for acquiring a forward contract:

  • Signing of a Framework agreement about payment and investment services.
  • You are legally obliged to have LEI number.
  • Deposit of cash collateral or getting a Dealing limit.
  • Minimum amount per transaction is EUR 10,000 or equivalent in another currency.
By entering into currency derivative transactions, the client assumes some types of risks( market risk – currency and interest rate risks, counterparty risk, liquidity risk, leverage). Everything always depends on the purpose and method of use of the derivative transaction concerned. Before signing a Framework Agreement and closing a transaction or at any time on request, dealers will be glad to explain you the individual types of risks, whether orally or in writing.

EXAMPLE

 
Exporter:
 
A company has agreed on a trade with an international company that is expected to pay EUR 100,000 for delivered goods in 3 months. The current (market) exchange rate for EUR/CZK is 27.70 and the forward rate for three months is 27.68.

Possible settlement date scenario:

EUR/CZK exchange rate at settlement dateCZK value without forwardCZK value with forward
Potential profit/loss 
vs spot rate at settlement date
(in CZK)
27.482.748.0002.768.00020.000
27.582.758.0002.768.00010.000
27.682.768.0002.768.0000
27.782.778.0002.768.000-10.000
27.882.788.0002.768.000-20.000
 
By entering into hedging transactions, all service providers become  involved in the counterparty of these transactions. Such involvement is covered in the following ways:
 
  • Blocking of client funds
  • Dealing limit
  • Dealing limit secured by bill of exchange
 

Our dealers  are happy to discuss the possibilities and individual conditions for hedging foreign exchange risks and will suggest the best option for your business.

Share This Post

About Author

Leave A Comment