A forward contract aims to take advantage of a favourable exchange rate by locking it in at a lower point now, while the actual transfer happens at a later date.
Forward contracts remove the uncertainty around FX exchange, helping businesses plan ahead. However, it’s important to remember that the exchange rate could improve further, in which case any benefit will be lost as they will be locked into the agreed rate.
Let’s look at the case study below to see how this would work in practice.
Business issue: Locking in a set future exchange rate
Business goal: Using a forward contract to reduce future currency risk
Memphis Royal Football Club (MRFC) agreed to buy two new players from a British club for a transfer fee of £10m (GBP) each but did not need to make the payment for three months. MRFC was concerned that the USD to GBP exchange rate might move against them during that time, and decided to fix the exchange rate in advance using a forward contract.
This allowed MRFC to know exactly how much the players would cost on the day they needed to pay for them. MRFC fixed a rate of exactly $1.5 to £1 to buy $30m worth of players. In the three months before the payment was due, the exchange rate moved between 1.47 and 1.54. On the day the payment was due, the rate was 1.53.
If MRFC had waited until the day the payment was due and exchanged GBP to USD at the prevailing rate, the players would have cost an extra $60,000.
To find a provider who offers forward contracts, simply conduct our comparison search on our site and then select a broker who deals in the two currencies you wish to manage. Typically, online-only providers do not offer these products.
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