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Forward Contracts
Forward contracts are foreign exchange transactions with a specified price, and are used to cover future foreign currency payables. To minimize the risk of the fall in the price of the currency in which the seller will be paid, a forward agreement is made between the holder of the currency and the prospective buyer. In a forward contract, the buyer and the seller agree to trade the currency at a particular rate. Forward contracts establish firm prices for exchange proceeds, and reduce transaction losses based on exchange rate fluctuations.
Forward contracts are sometimes suitable tools for an exporter. Forward contracts are one of the techninques frequently used by exporting companies to hedge against foreign exchange rate risk. Other techniques used to manage FX related risk include:
- Futures trading
- Options trading
- Swaps
Forward exchange transactions involve the purchase or sale of foreign currency at an exchange rate established when the contract is created calling for payment and delivery at a specified future date. Many forward exchange contracts have maturities of one month, three months or six months.
Edited by Michael C. Dennis. Mr. Dennis is a consultant specializing in improving the quote to cash process.