Forward Rates

M.D. Adamson - OTP

A forward exchange rate essentially refers to an exchange rate that is quoted and traded today but for delivery and payment on a set future date.

A forward contract is an agreement, usually with a bank, to exchange a specific amount of currencies sometime in the future for a specific rate—the forward exchange rate.

Sometimes, a business needs to do foreign exchange transaction but at some time in the future. For example, a company might make a sale of its goods internationally but will not receive payment for at least one year. So how is it able to price its products or goods without knowing what the foreign exchange rate, or spot price as it is called, will be between the United States dollar (USD) and the Euro (EUR) 1 year from now? It can do so by entering into a forward contract that allows it to lock in a specific rate in 1 year or more so that they can agree upon a set exchange rate without knowing exactly what it will be.