Forward contract

A forward is concluded directly between two parties, usually a company and a bank. No exchange is involved in the deal, so the terms are tailored to the client: the amount, the currency, the date. Both parties must perform the contract even if the market has moved against them.

How it works

An importer knows it will pay a supplier in foreign currency in three months. It enters into a forward with a bank to buy that amount at a rate calculated today. In three months, the bank sells the currency at that rate, whatever the market rate is. The importer knows its rouble costs in advance.

The forward rate is not the same as the current rate. It is calculated from the current rate, adjusted for the difference in interest rates between the two currencies.

Types

• Deliverable: on the settlement date, the parties exchange the currency in full.
• Non-deliverable (NDF): no currency is exchanged; one party pays the other the difference between the contract rate and the market rate.
• Commodity: for the delivery of raw materials or goods at a fixed price.

Pros and cons

A forward removes the currency risk on a specific payment. But you also lose the gain from a favorable move in the rate. The bank requires a credit limit or collateral. You can exit a forward early only by agreement with the bank, and usually at a cost. If the delivery falls through, the forward obligation remains.

How it compares with a payment through a broker

In a deal through a broker, the exchange rate is fixed in the payment order for each payment before the roubles are debited. This is not a forward: the fixing applies to a payment being made now, not months ahead. Protection against rate movements over a long period comes from hedging, which companies usually arrange with their own bank.