Glossary
Forward contract
Lock in an FX rate today for settlement on a future date.
A forward contract is an agreement to buy or sell one currency for another at a rate fixed today, for settlement on a specified future date. Forwards are commonly used to protect known future receivables or payables against rate movements between the date of commitment and the date of settlement.
In practice
How this works for a UK business
A forward contract is priced from the spot rate adjusted for the interest-rate differential between the two currencies over the contract period — this adjustment is called the forward points. It is not a forecast of where the market will move; it reflects the mathematical relationship between spot rates and interest rates in each currency, published daily and applied consistently by the provider.
Forwards are typically used where a business has a firm, dated commercial obligation: a purchase order priced in a foreign currency with payment due in 30, 60 or 90 days, or a sales contract where the invoice will be settled in three months' time. Because the rate is fixed at the point the contract is agreed, the business knows the exact GBP cost or receipt in advance, which supports budgeting and margin protection.
Providers commonly distinguish between a fixed forward, where settlement happens on a single specified date, and a flexible (or window) forward, which allows drawdown at any point within an agreed date range — useful where the exact payment date is not yet certain, for example when shipment timing can slip.
Forward contracts are a commitment, not an option: the business is obliged to complete the contract at the agreed rate on (or within) the agreed date, regardless of where the spot rate has since moved. Providers will typically require a deposit or margin, and may request further margin if the market moves significantly against the contract before settlement.
Worked example
Pitfalls
Common mistakes
- Booking a forward for an amount larger than the underlying commercial exposure, which effectively creates a speculative position rather than a hedge.
- Treating the forward rate as a market forecast rather than a function of interest-rate differentials — a forward rate can be higher or lower than today's spot rate depending on which currency carries the higher interest rate.
- Not allowing for shipment or invoice-timing slippage, then having to extend or unwind a fixed-date forward at short notice, which can carry a cost.
- Forgetting that a forward is a binding obligation: if the underlying commercial deal falls through, the business may still need to settle or close out the contract.
FAQs
Frequently asked questions
See also
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