FX Forward
Also known as: Outright forward
Lock an exchange rate for a future date — the corporate world's everyday currency hedge.
- Asset class
- Foreign exchange
- Instrument type
- Forward (linear)
- Traded
- OTC
- Typical users
- Corporates, asset managers, funds
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.
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.
AdvancedPricing & valuation
Covered interest parity
The forward rate follows from a riskless round trip (borrow, convert, invest, convert back):
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:
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.