1.4 – Forward Transactions

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Forward transactions in the foreign exchange market consist of a contractual agreement between two parties to participate in a currency exchange transaction on a different date than the spot value date at a specified exchange rate.


The spot value date in the forex market — for which the majority of forex deals are made — is for settlement in two business days, except for the U.S. Dollar/Canadian Dollar pair which has a one business day settlement period.


This tends to imply that forward transactions are usually done for settlement after more than two business days from the transaction date.


The Forex Forward Market


Typically, forward contracts are entered into via the OTC or Over-the-Counter forward market. In a forward transaction, representatives of the two counterparties work out the details of the contract, generally over the telephone.


The forex forward contract is also commonly known as a forward outright or as forward cover. Such transactions involve the buying of one currency and the selling of another currency simultaneously at a specified rate of exchange for a delivery date other than the spot date.


The Interbank forward market tends to trade swaps rather than on an outright basis. Swaps often trades actively for standardized value dates ranging from one week to one year from the spot value date. This would be for value in 7 days, 30 days, 60 days, 90 days, 120 days, 270 days and 360 days, if using a 30/360 calendar.


Forward contracts falling outside of these so-called “straight” dates are often referred to as “odd date” forward contracts. They are commonly used by bank clients like corporations who need custom forward dates for specific hedging requirements.


Pricing for odd date forwards can be easily obtained by using the prevailing spot rate and market pricing for the surrounding straight date forward swaps to determine an outright price for the odd date forward contract settling in between.


The Forward Value or Delivery Date


The forward value date, also called the delivery date, is an agreed upon date at which the two parties have consented to deliver the currencies among themselves at the price specified in the forward contract. The value date can be in a few days for short dated forwards to up to several years after the transaction date in the case of long dated forwards.


Because value dates are flexible, especially in the Interbank forex market, hedgers can have forward contracts tailored specifically to their currency delivery needs based upon their expected cash flows or exposures involving foreign currency.


Execution of a Forward Transaction


Because of the close correlation between the forward outright rate and the spot value rate, executing a forward transaction typically involves making a spot trade initially in the chose currency pair in order to fix that more active portion of the forward price.


In order to obtain the forward rate, the two parties will then usually add or subtract the forex swap points, as appropriate, from the spot rate in order to obtain the rate for the desired forward value date that pertains to the chosen currency pair.


Forex swap points are derived mathematically from the interest that would accrue to the holder of one currency versus the interest that would have accrued to the holder of the second currency during the time frame covered in the forward contract.


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