What is a forward contract?
Lock in an exchange rate today for an international money transfer you'll send up to two years in the future.
When you send money overseas, the exchange rate you get has a major impact on the cost of the transaction. But the foreign exchange market can be volatile, with rates fluctuating all the time.
So if there's a good exchange rate available today, you might want to lock in that rate for future international transfers, protecting yourself against any potential exchange rate drops. That's where a forward contract comes into play.
What is a forward contract and how does it work?
A forward contract is an agreement between two parties to carry out a future trade at a predetermined price. Forward contracts are commonly used in commodities trading, but they're also very useful tools for individuals and businesses sending international money transfers.
With a forward currency contract, you can exchange currencies on a future date, but at an exchange rate you lock in today. Here's how it works.
Let's say you know you will need to make an international payment in six months' time. Exchange rates are favorable right now, so you decide to take out a forward contract to lock in today's rate. Then, six months later when your transfer is sent, you know exactly how much it is going to cost you — even if the mid-market exchange rate at that time is very different.
That's why some transfer companies refer to forward contracts as a "buy now, transfer later" option.
Pros and cons of forward contracts
- Save money. A forward exchange contract lets you protect yourself against exchange rate fluctuations and lock in a great exchange rate today.
- Cost certainty. A forward contract gives you the peace of mind of knowing exactly how much your future international transfer will cost.
- Cash flow management. Using a forward contract makes it easier for business owners to manage their cash flow and budget for future expenses.
- Hedging. A forward contract is a useful hedge against fluctuating exchange rates, allowing businesses that regularly make international payments to manage their currency exchange risk.
- Transfers sent on time. Another benefit of forward contracts is that they allow you to schedule your transfer to be sent on a specific date, removing the risk of you forgetting to send money at the right time.
- You could miss out on a better rate. The exchange rate could improve before the date of your transaction, so entering into a forward contract could mean you miss out on a better deal. With this in mind, you may choose to only use a forward contract for a portion of the total amount you need to send.
- Your needs may change. If you don't know for certain exactly how much currency you'll need to exchange in your future transaction, you could get caught out. For example, you may enter into a forward contract to send $20,000 overseas, but later find out that you only need to send $15,000.
- You may need to pay a deposit. You'll typically need to pay a 10-20% deposit when you enter into a forward contract.
Example of a forward contract: Buying a property abroad
John's son is moving to the UK in six weeks, and John plans to send $50,000 to his son to help him buy an apartment in his new country. But with the Aussie dollar trading at the highest level it's been against the British pound in the past 12 months, John is worried that it's only a matter of time before the AUD/GBP rate starts to fall.
Rather than just accept whatever rate he will get in six weeks' time, John decides to enter into a forward contract. He contacts a money transfer company to lock in the current exchange rate of 1 AUD = 0.59 GBP.
As you can see in the table below, if the exchange rate moves as John predicts, using a forward currency contract can result in significant savings.
|Without a forward contract||With a forward contract|
|Exchange rate||1 AUD = 0.57 GBP||1 AUD = 0.59 GBP|
When should I use a forward contract?
There are multiple situations and circumstances when a forward contract could be the right option for you. These include:
- If you're worried the exchange rate will move against you. From interest rates and inflation to political developments, there are multiple factors that can influence currency exchange rates. So if you think the rate for the currency pair you're exchanging is going to move against you, a forward contract offers welcome protection.
- If you're sending regular international payments. For individuals and businesses that regularly send large amounts overseas, exchange rate volatility can have a big impact on your bottom line. Forward contracts are a very useful tool for reducing your currency exchange risk and ensuring that your cash flow is easy to manage.
- If you're making a big purchase. If you need to exchange money to buy an overseas property or make any other major purchase, even a small dip in the exchange rate could make a huge difference to the cost of your transaction. A forward contract is therefore well worth considering.
- If you know the exact amount you will need to send. Forward contracts are worth considering when you know how much money you need to exchange, to which currency, and when. If your needs change and you need to cancel some of the contract or send a larger amount, it could cost you money.
Types of forward contract
There are a few different types of forward contract to choose from depending on your transfer needs:
- Fixed forward contracts. This is the most common type of forward contract and ensures that the currency exchange will take place on a specific date in the future.
- Open/flexible forward contracts. With an open forward contract, you have the option to settle the contract at any time up to or on the specified date.
- Window forward contracts. This type of contract allows you to perform a currency exchange transaction within a specific date range, or window.
What companies offer forward currency contracts?
Many international money transfer companies do not offer forward contracts. However, the good news is that there are several foreign exchange providers that do offer these advanced transfer tools. Some of the options you might like to consider include:
- TorFX. You can lock in an exchange rate up to two years before sending the transfer, but you'll need to pay a 10% deposit.
- OFX. You can lock in an exchange rate for up to 12 months when you take out a forward contract with OFX.
- Xe. Xe's money transfer service allows you to lock in your exchange rate so you can "buy now, send later".
- WorldFirst. You can lock in the current exchange rate for up to two years with a WorldFirst forward contract.
- Banks. While forward contracts are more commonly associated with specialist foreign exchange companies, major banks like NAB and CommBank also offer forward exchange contracts for business customers.
Money transfer providers that offer forward contracts
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