Forward contract to hedge your large international payments

							Forward contract to hedge your large international payments

Forex :-
Forex is also known as FX and it is an abbreviation of “Foreign Exchange”. It is the biggest financial market of the
world where people constantly sell or buy currencies of different countries. In another aspect, it is exchanging
one currency with another. The most fascinating thing of this forex market is that currency rates of any nation
keeps fluctuating all the time thus it is all about your luck whether you will get positive movement or negative
movement of currency exchange rates. This process of currency exchange is also known as “Currency trading” or
simply “trading”. Over the years, the professionals have discovered several risk management techniques to trade
safe in forex and forward contract is one of those techniques.

What is forward contract?
Forward contract is an agreement done in the forex market between the buyer and seller. In this agreement
the currency exchange rate of the future transaction is decided on the current market basis. Even the future
transaction date and the delivery date (contract expiration date) is also decided in this agreement. Once signed
for this legal contract, both the parties have to follow the terms defined in the agreement.

In forward contract, the exchange rate is decided before the actual transaction takes place thus it also known as
the forward exchange rates or forward rates. Let's see one example to understand how and why forward contract
is used? In forex, forward agreement is used mostly to sell or buy asset in the foreign country. Suppose, you are
resident of UK and want to buy asset in USA, say for example a home. The current exchange rate of GBP/USD is
1.60 and you need to make payment of 1,00,000$. You have already contacted seller and you both have agreed
on this price. As it is a big amount to pay, you are selling some bonds and all these stuff will take around 2
months and then only you will be able to make payment. Also, in last few months you are witnessing constant fall
in the GBP/USD exchange rates. It may fall by some more percentage if you wait for 2 months more to make
payment in US dollar.

Forex companies give resolution and security in such situation and offer you negotiated rate based on the live
rate for the future delivery of the asset or commodity. The company make an agreement between you and seller
wherein the exchange rate, transaction date is fixed. When you make the payment after two month the exchange
rate in the market is 1.40 but you need not to worry as you will be buying home as per the 1.60 rate fixed or
locked in the contract. As per the forward exchange rate, you will be paying 62,500 GBP. But if you have not
selected forward exchange rate, you need to pay 71,429 GBP at the live rate of 1.40. Choosing forward
exchange rates, you saved 8928.57 GBP.

In above case, you can see how you safeguarded your transaction from the negative movement of the exchange
rates. However, is it always the case that the exchange rate of UK and USA will always move downwards.
Ofcourse not. Exchange rate of two currencies are dependent on the currency rate of individual nation. And
currency rate of any nation is governed by so many economical and financial factors of that nation. In short, a
minor change in any economical or political factor of US or UK can make major impact on the GBP/USD exchange
rates and ultimately on your transaction. It may also be possible that instead of falling down, the exchange rates
goes high and you may lose some profit! Decision is yours whether you want to secure your fund or play risk?