FX Forward

Also known as: Outright forward

Lock an exchange rate for a future date — the corporate world's everyday currency hedge.

3 min read · 608 words · Updated

1 · SnapshotThe one idea to remember
Key intuition: a forward doesn't remove currency risk from the world; it transfers it to a dealer for a price implied by interest rates — and takes your upside as payment.
2 · BeginnerWhat is it, really?

An FX forward fixes today the exchange rate for a currency conversion on a future date — three months, a year, whatever you agree. A European exporter expecting $10M from a US customer in six months can sell those dollars forward now: whatever EUR/USD does meanwhile, their euros are locked.

The forward rate is not a prediction. It differs from today's spot rate by the "forward points", which come purely from the interest-rate gap between the two currencies. If dollar rates exceed euro rates, the forward dollar is cheaper than spot — not because markets expect the dollar to fall, but because arbitrage math says so.

This is the workhorse hedge of global business: no premium to pay, no decision to make later — certainty, purchased at the price of giving up any favourable move.

P&L at maturity versus the locked forward rate — symmetric both ways.
F₀Long forwardUnderlying price at expiryProfit / loss

Point at a line to pick it out from the others.

Today's rate, tomorrow's exchange
The companyhedging a paymentThe bankthe counterparty1Nothing is paid2Collateral, if an annexapplies3The currency being sold4The currency being bought

a paymentonly if a condition is metnot a payment

The forward rate is arithmetic on two interest rates, not a forecast — and the gap until settlement is what has to be collateralised.

On the trade date

  1. The company → The bank The rate is set so the contract is worth zero to both sides. There is no premium, which is the difference from an option.

While it runs

  1. The company → The bank Between professionals the daily change is margined. A corporate client is often granted a credit line instead, and the exposure simply accumulates against it.

On the settlement date

  1. The company → The bank Delivered in full at the agreed rate, whatever spot has done in the meantime.
  2. The bank → The company The company gets exactly the amount it budgeted for. It has also given up any benefit if the market moved its way — which is what a hedge is, not a defect in one.
Asset class
Foreign exchange
Instrument type
Forward (linear)
Traded
OTC
Typical users
Corporates, asset managers, funds

Which risks decide the outcome

Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.

  • Marketdecides it
  • Creditmatters
  • Liquiditymatters
  • Fundingbarely applies
  • Operationalmatters

What decides it here. The rate is arithmetic on two interest rates rather than a forecast. The risk is the counterparty across the gap, and the hedge giving up the benefit if the market moves your way.

What the five mean, and which one decides where →

3 · IntermediateHow it works in practice

Mechanics

  • Forward points: quoted as pips added to spot (EUR/USD spot 1.1000, 6m points +80 → forward 1.1080).
  • Settlement: physical exchange of both currencies at maturity, or cash-settled difference.
  • Window forwards: corporates often buy flexibility to settle within a date range.
  • Rolling: hedges are extended with FX swaps (spot + forward pair) rather than new outrights.

Hedging in practice

The exporter above sells $10M forward at 1.1080 (≈ €9.03M locked). If EUR/USD ends at 1.05, the customer's dollars would have bought €9.52M — the hedge "cost" ~€500k of forgone gain. At 1.20 it saved ~€700k. Over time these wash out except for the forward points — the hedging carry, which for high-rate-differential pairs can be several percent per year and dominates the decision.

Credit and documentation

Forwards are bilateral; banks charge credit/valuation adjustments into the rate for uncollateralised corporates. Funds trading under CSAs post margin; since 2022, many jurisdictions require variation margin even on physically-settled FX forwards for financial counterparties.

Worked example: 1y USD/JPY forward with US rates 5%, Japan 0.5%: spot 150 → forward ≈ 150 × 1.005/1.05 ≈ 143.6. A Japanese investor hedging US bonds gives up ~4.5%/yr in points — often the entire yield advantage. This single number decides whether a foreign bond is worth owning hedged.
4 · AdvancedPricing & valuation

Covered interest parity

The forward rate follows from a riskless round trip (borrow, convert, invest, convert back):

$$ F_{0,T} = S_0\,\frac{(1 + r_q T)}{(1 + r_b T)} \qquad\Longrightarrow\qquad \text{points} = F - S $$
What the symbols mean
  • Fthe forward or futures price
  • Tmaturity, in years
  • Sthe price of the underlying today
  • rthe interest rate, per year
  • qthe dividend yield, per year

Valuation of a seasoned forward struck at \(K\): \(V_t = \big(F_{t,T} - K\big)\,P_q(t,T)\) in quote-currency terms.

The cross-currency basis

Post-2008, CIP fails persistently against pure OIS rates: the market forward embeds a basis \(b\) — effectively the price of dollar balance sheet:

$$ F = S\,\frac{1 + (r_q + b)T}{1 + r_b T} $$
What the symbols mean
  • Fthe forward or futures price
  • Sthe price of the underlying today
  • rthe interest rate, per year
  • qthe dividend yield, per year
  • Tmaturity, in years

Negative EUR/JPY-vs-USD bases mean dollar borrowers via FX pay a premium over direct funding. The basis widens at quarter-ends (regulatory snapshots) and in dollar-stress episodes — a monitored global funding indicator, and the reason central-bank swap lines exist.

Hedged-return arithmetic

For an investor hedging foreign assets, hedged return ≈ local asset return + (domestic − foreign short rate) − basis costs. Hedging demand therefore itself responds to rate differentials, creating reflexive flows (the Japanese lifer bid for hedged/unhedged Treasuries as points move).

NDF cousin

Where currencies aren't freely deliverable, the same economics trade as non-deliverable forwards — cash-settled against a fixing.

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.

5 · Desk notesHow practitioners think about it
Practitioner note: forward points are a market of their own. Corporates think "what rate do I get"; the interbank desk thinks "what does dollar funding cost through quarter-end" — same instrument, two different markets in one price.

Now say it back

Close the page and give FX Forward in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.

  1. Who wants what — two parties wanted opposite things badly enough to write it down.
  2. What the contract obliges, and when — not the payoff; the obligation.
  3. Where the money comes from — name the source, or you have described a hope.
  4. What makes it lose — the ordinary way, not the dramatic one.

Do it with a clock → · why these four

Put FX Forward beside any other instrument →

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