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What is a forward contract?

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If your business makes frequent transactions with foreign currencies, a forward contract could be a helpful tool to protect your transactions against market fluctuations.

What is a forward contract?

A forward contract is a “hedging” tool that doesn’t require upfront payment. When two parties sign a forward contract, they agree to trade a certain amount of one currency for another currency at a later date. At the same time, they set the exchange rate for the future trade.

Why is a forward contract useful?

The main reason you would use a forward contract is to limit your risk. Exchange rates change day to day, and they can spike or drop on a dime. It’s especially tough to predict what exchange rates will be a long time from now. To protect yourself, a forward contract essentially locks in the exchange rate that you’ll receive in the future.

Forward contracts: An example

Let’s say you’re an exporter in the United States selling factory equipment. You sell 10 pieces of equipment to an importer in France, stipulating that the importer will pay you in five months.

When the importer pays you, he’ll send the funds in euros, so you’ll need to convert them to dollars.

You know today’s exchange rate between dollars and euros. But if the importer pays you in five months, who knows what the exchange rate will be at that time.

For this reason, you sign a forward contract. This lets you lock in the exchange rate you’ll get for trading euros into dollars five months from now.

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$0 1 - 2 days USD 0.00 19.383 MXN 96,916 Save your time and money with XE Money Transfer for business Go to site Show details
$1 1 - 2 days USD 0.00 19.169 MXN 95,845 Great rates, and fast, efficient payment processing in most currencies Go to site Show details
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GBP 5,000 Same day USD 0.00 19.305 MXN 96,527 Increase business efficiency with zero transaction fees and same-day transfers. Go to site Show details
USD 5,000 1 day USD 0.00 19.208 MXN 96,040 Venstar will support you through the entire process of your international transactions, from start to finish. Go to site Show details

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Min. Transfer Amount Transfer Speed Online Transfer Fee Rate Amount Received Description CTA Details
USD 0 1 - 2 days USD 0.00 19.227 MXN 96,137 Offering no maximum and no minimum limit transfers with $0 fees. Go to site Show details
USD 1 1 - 2 days USD 0.00 19.383 MXN
96,916
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USD 1 Within an hour USD 0.00 19.305 MXN 96,527 Use promo code 3FREE to send your first 3 transfers with no fee. Send to 110+ countries for bank-to-bank deposit, cash pickup or mobile top-up. Go to site Show details
USD 1,000 1 day USD 0.00 19.189 MXN 95,943 No-maximum limit transfers with competitive exchange rates for 100+ currencies. Go to site Show details
GBP 1,000 1 - 2 days USD 0.00 19.189 MXN 95,943 Exclusive: Minimum transfer of $1,000 for Finder readers (normally $5,000).
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USD 5,000 1 day USD 0.00 19.052 MXN 95,262 Venstar will support you through the entire process of your international transactions, from start to finish. Go to site Show details
USD 50 1 - 2 days USD 0.00 19.052 MXN 95,262 Simple, zero-margin exchange rates, plus earn loyalty points on sign up, referral and every transaction. Go to site Show details

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Are there any drawbacks?

Even though a forward contract can protect you if a currency depreciates, you give up what you’d gain if the currency appreciates. Many people find that’s not a huge deal — you’re not losing money. But it can sting when you lose out on a big exchange rate swing in your favor.

What are the pros and cons of forward contracts?

Pros

  • Protect yourself. Forward contracts allow you to protect your finances against the impact of fluctuating exchange rates.
  • Buy now, pay later. You don’t have to pay for the full cost of your transfer until it is actually placed, which could be up to 12 months into the future.
  • Choose a rate that suits you. Forward contracts give you the power and freedom to secure an exchange rate that suits your financial needs.

Cons

  • The exchange rate could improve. Predicting the future value of a currency can be difficult, so there is a risk that the exchange rate will rise in the interim and cost you money.

What else should I know?

A forward contract is binding — even when one party will lose a lot on it.

You can also create a forward contract with your bank. The bank will offer you a forward rate that’s slightly less than the current exchange rate.
An introduction to forex futures

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