When you send money overseas, the exchange rate you get has a huge impact on how much it will cost you. But the foreign exchange market can be volatile, with rates fluctuating every day.
If you're planning on exchanging currencies sometime in the future and there's a good exchange rate available today, you might want to lock in that rate right now to protect against any potential exchange rate drops.
That's where a forward exchange contract comes in.
What is a forward contract?
A forward contract is an agreement between two parties to carry out a trade in future but at a price that is determined today.
Forward contracts are commonly used by commodities traders, but they can also be useful 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.
How do forward contracts work?
Let's say you need to make an international payment in 6 months' time.
You believe exchange rates are favourable right now and might get worse over the next 6 months.
You choose to take out a forward contract to lock in today's rate.
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.
Of course, there's no guarantee that the rate you lock in today will be better than the rate you would have received had you exchanged money at a later date.
Predicting currency movements is notoriously difficult, even for professional forex traders, and it's possible a forward contract can end up getting you a worse deal.
Why use a forward exchange contract?
There are a number of reasons both individuals and businesses may want to use a forward contract:
Save money. A forward exchange contract lets you protect yourself against exchange rate fluctuations and potentially lock in a better rate today.
Peace of mind. A forward contract guarantees that you will receive a certain rate, which can help with budgeting or planning.
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.
Which companies offer forward currency contracts?
Here are some of the international money transfer services that offer forward contracts in Australia:
TorFX. You can lock in an exchange rate up to 2 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.
Some banks like NAB and CommBank also offer forward exchange contracts for business customers.
We currently don't have that product, but here are others to consider:
How we picked these
Forward contract example: Moving abroad
John's son is moving to the UK in 6 weeks and John plans to send $5,000 to his son to help him get settled.
But with the Aussie dollar currently trending down against the British pound, John is worried that the AUD/GBP exchange rate will drop even further over the next few weeks.
Rather than just accept whatever rate he will get in 6 weeks' time, John decides to use a forward exchange contract.
He contacts a money transfer company to lock in the current exchange rate of 1 AUD = 0.51 GBP, which means he is guaranteed to receive £2,550 when he exchanges the $5,000.
Over the next 6 weeks, the Australian dollar continues to weaken against the pound, dropping to an exchange rate of 1 AUD = 0.46 GBP.
If John had waited to exchange money, he would have only received £2,300 when he exchanged the $5,000, compared to the £2,550 he received by using a forward contract.
By using a forward contract, he ends up saving £250.
Finder survey: Do Australians think the Australian dollar will get stronger over the next 12 months?
Response
Female
Male
No
63.1%
50.2%
Yes
36.9%
49.8%
Source: Finder survey by Pure Profile of 1004 Australians, December 2023
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 are the potential drawbacks of using a forward contract?
There are 3 key downsides to using a forward exchange contract:
1. You could miss out on a better rate
The exchange rate you lock in with a forward contract may end up being worse than the rate you would have received later, which means it could actually cost you money.
2. 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. Say you want to send $20,000 overseas, but later find out that you only need to send $15,000. You'd either need to cancel the contract or end up with $5,000 of foreign currency you don't necessarily need.
3. You may need to pay a deposit
You'll typically need to pay a 5-20% deposit when you enter into a forward contract, as well as other fees.
Our expert says: Predicting exchange rates is hard
"While a forward contract promises certainty, it doesn't guarantee a better deal. You should mostly use a forward contract if you're looking for peace of mind or because you need to lock in a certain rate for financial reasons, not because you're trying to predict currency movements."
A forward contract is traded over the counter (OTC) and is an agreement negotiated between two parties. Meanwhile, a futures contract is a standardised contract that can be publicly traded on an exchange.
Yes, you can cancel a forward contract by entering into a transaction to reverse the original contract. This may result in a cost or a gain to you.
The maximum length of time allowed for a forward contract varies depending on the currency exchange service you choose. While some providers offer a maximum contract length of one year, others allow you to lock in an exchange rate for up to two years.
A forward contract allows you to hedge against exchange rate fluctuations. By locking in the current exchange rate for a future transaction, you can protect yourself against the risk of a falling exchange rate. That's why forward contracts are a common hedging strategy businesses can use to manage their currency exchange risk.
Tim Falk is a writer for Finder, writing across a diverse range of topics. Over the course of his 15-year writing career, Tim has reported on everything from travel and personal finance to pets and TV soap operas. When he’s not staring at his computer, you can usually find him exploring the great outdoors. See full bio
Tom Stelzer is a journalist with 6 years of experience covering personal finance, specialising in investment and cryptocurrency. With a Master of Media Arts and Production and a Bachelor of Communications in Journalism from the University of Technology Sydney, Tom provides expert analysis on digital assets and market trends, helping readers navigate the fast-evolving world of finance. See full bio
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