Forward transactions: what is it and “what are they eating with”?
A forward transaction is a type of transaction in which one of the parties undertakes to sell a certain amount of foreign currency to the other party at a predetermined time at a specific exchange rate. In this case, the course will be specified in the agreement .
Thanks to forward transactions, you can buy and sell currency in the future without worrying about possible price hikes. This opens up great opportunities for businessmen to manage risks, and allows you not to worry about unforeseen changes in the exchange rate of the national currency.
Consider an example of a real forward transaction:
A large Russian plant plans to conclude a contract with foreign suppliers for the purchase of raw materials worth $ 300,000, which must be paid in 3 months. The plant management concluded that the conditions are quite acceptable. So, taking into account the current dollar rate – 59 rubles. – in 3 months it is necessary to pay 17 million 700 thousand rubles. But what will happen if suddenly the ruble falls, for example, to 65 rubles. for 1 dollar? Obviously, there is nothing good for the plant, because the contract amounts will already amount to 19 million 500 thousand rubles. This is where the forward contract will come in handy. Suppose a broker provides a leverage of 1:50, and the plant is required to make something like a deposit of 10% (this is the maximum) of the total contract amount, thus, the purchasers guarantee the purchase of raw materials at a fixed exchange rate.
Forward transactions are well suited to international companies because they protect against unexpected cash losses. But in recent years, the number of private investors has been growing, using this type of contracts in order to protect themselves in case of major overseas purchases, such as real estate, or, if necessary, to pay for training, long business trips, etc. And more and more often this tool is used by merchants in financial markets for the purpose of making profit.
The main advantage of working with a currency forward, as opposed to trading currency pairs, is the lack of swaps. A great option for long-term transactions, because you do not have to pay for the daily position transfers. Taking into account the duration of the transaction for several months – a significant savings in the trading deposit!
Specific features of currency forwards:
- non-negotiable and binding contract;
- the parties must agree on the size, time and place of delivery, clarify the quality of the asset, take into account other requirements of the parties;
- this contract is not subject to mandatory reporting;
- the main advantage is a clearly fixed price for a specific date;
- as the main drawback – regardless of the value of the price, none of the parties will be able to refuse to perform the contract.
Forward transactions are classified as urgent . This category includes:
a) futures contracts ;
b) option contracts ;
c) swap contracts ;
d) various combinations of the above transactions.
Consider another example of a EUR / RUR forward contract.
The company plans to buy imported goods in 2 months. Of course, this requires a currency. In order to reduce risks, the company resorts to hedging and concludes a forward contract for the euro for 2 months.
The contract price on the date of its completion will be calculated at the following rate: 69 rubles for 1 EUR. But, in the foreign exchange market, the rate is constantly changing, and after 2 months the ruble fell to 72 rubles for 1 euro. But our trading company will still receive the necessary amount at the rate of 69 p. To do this, you must transfer your deposit to your broker.
What is the difference between a futures contract and a forward contract?
A futures contract is a fairly standard contract between two entities. One of them undertakes to deliver the underlying asset at the agreed date and time, and the other to buy. Futures refers to exchange-traded instruments, it is traded on the exchange, and the rules for conducting such transactions are governed by the rules of the exchange.
Some more differences between forwards and futures:
- a forward transaction allows the parties to independently determine the scope of supply, while in futures, the exchange sets the volume of the contract, and the parties can only trade a certain number of contracts;
- futures allow you to trade assets, regardless of their quality, mutual agreement is enough; futures contracts are defined by the exchange;
- the forward has limited liquidity, futures are considered highly liquid (although this figure varies depending on the underlying asset).