A forward transaction is an agreement between the bank and the client to buy or sell a currency amount at a specified point in time in the future. This is relevant for clients who wish to hedge their future income and expenditure in foreign currency.
The exchange rate (forward rate) is agreed when the transaction is carried out. The forward transaction is settled on the maturity date, thus there is no liquidity effect prior to the maturity date. Advantages Clients can hedge the exchange rate on their future income and expenditure in the relevant currency. Forward transactions allow clients to reduce their currency risk. Clients have a more accurate basis for selling and buying calculations, and are better able to forecast their liquidity position and results in the longer term. Disadvantages With forward transactions, the client misses out on the opportunity to make a possible exchange gain during the period from when the transaction is carried out up until the maturity date. A currency buyer can therefore lose out on a drop in the exchange rate, and likewise a seller can lose out on any exchange rate rise during the course of the transaction. Pricing The forward rate is composed of a spot rate and an addition to or deduction from the spot rate. The addition or deduction reflects the interest rate margin between the currencies involved for the period in question. Thus the forward rate does not reflect the bank’s expectations as regards future exchange rate trends. Term The maturity date is normally between one week and 12 months in the future. DNB Markets also issues prices for periods exceeding 12 months. This is a product that requires a credit line.