Outright Forward: Difference between revisions
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'''Outright Forward''', also referred to as a ''forward'', is a type of foreign currency exchange forward contract functioning in the outright forward [[market]]. Such a contract is a [[firm]] and binding obligation agreed upon by both parties. It concerns the exchange of one currency for a counter currency at a '''forward rate''' at a '''specified date in the future'''. Neither the rate nor the date is subject to changes. Therefore, the currencies are not to be exchanged till the given value date arrives<ref> Brown B., (2017) Chapter 3 </ref><ref> CFA Institute, (2017) pp. 524 </ref>. | '''Outright Forward''', also referred to as a ''forward'', is a type of foreign currency exchange forward contract functioning in the outright forward [[market]]. Such a contract is a [[firm]] and binding obligation agreed upon by both parties. It concerns the exchange of one currency for a counter currency at a '''forward rate''' at a '''specified date in the future'''. Neither the rate nor the date is subject to changes. Therefore, the currencies are not to be exchanged till the given value date arrives<ref> Brown B., (2017) Chapter 3 </ref><ref> CFA Institute, (2017) pp. 524 </ref>. | ||
There is a wide range of maturities available in this market, whereas the completion of all transactions in the spot exchange market is always due within two days (T + 2)<ref> Chisholm A., (2009) Chapter 3.1 </ref>. Banks at large quote the forward exchange rates for some fixed periods, for instance one week, one month, three months, six months or a year. Calculation of rates for broken dates is also possible<ref> Brown B., (2017) Chapter 3 </ref>. To establish a forward rate which is to be used for delivery on a given value date, a notion of [[forward points]] (known as ''pips'') must be applied. The forward points are the number of basis points deducted from or added to the spot rate of a currency pair <ref> Neftci S.,(2008) pp. 76 </ref><ref> CFA Institute, (2017) pp. 425 </ref>. | There is a wide range of maturities available in this market, whereas the completion of all transactions in the spot exchange market is always due within two days (T + 2)<ref> Chisholm A., (2009) Chapter 3.1 </ref>. Banks at large quote the forward exchange rates for some fixed periods, for instance one week, one month, three months, six months or a year. Calculation of rates for broken dates is also possible<ref> Brown B., (2017) Chapter 3 </ref>. To establish a forward rate which is to be used for delivery on a given value date, a notion of [[forward points]] (known as ''pips'') must be applied. The forward points are the number of basis points deducted from or added to the spot rate of a [[currency pair]] <ref> Neftci S.,(2008) pp. 76 </ref><ref> CFA Institute, (2017) pp. 425 </ref>. | ||
'''Forward Premium vs. Forward Discount''' since a forward rate on a currency A is lower than a spot rate, then the currency A is trading at a forward discount. Accordingly, the currency B is trading at a forward premium <ref> CFA Institute, (2017), pp. 425 </ref>. | '''Forward Premium vs. Forward Discount''' since a forward rate on a currency A is lower than a spot rate, then the currency A is trading at a forward discount. Accordingly, the currency B is trading at a forward premium <ref> CFA Institute, (2017), pp. 425 </ref>. | ||
Revision as of 23:28, 20 January 2023
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Outright Forward, also referred to as a forward, is a type of foreign currency exchange forward contract functioning in the outright forward market. Such a contract is a firm and binding obligation agreed upon by both parties. It concerns the exchange of one currency for a counter currency at a forward rate at a specified date in the future. Neither the rate nor the date is subject to changes. Therefore, the currencies are not to be exchanged till the given value date arrives[1][2].
There is a wide range of maturities available in this market, whereas the completion of all transactions in the spot exchange market is always due within two days (T + 2)[3]. Banks at large quote the forward exchange rates for some fixed periods, for instance one week, one month, three months, six months or a year. Calculation of rates for broken dates is also possible[4]. To establish a forward rate which is to be used for delivery on a given value date, a notion of forward points (known as pips) must be applied. The forward points are the number of basis points deducted from or added to the spot rate of a currency pair [5][6].
Forward Premium vs. Forward Discount since a forward rate on a currency A is lower than a spot rate, then the currency A is trading at a forward discount. Accordingly, the currency B is trading at a forward premium [7].
Strengths and Weaknesses
Main advantages and disadvantages of outright forward contracts include [8]:
- Such a contract helps to protect oneself against unpredictability, instability and volatility of markets
- It can be used for speculation and risk management
- Investors, importers, exporters etc. have a means to pre-empt the adverse effects of fluctuation in exchange values
- The forwards do not entail any up-front payments
- However, the parties agreeing beforehand on a fixed rate forego potential profits, as a set forward rate may differ significantly from a future spot rate. Thus, profits may be lower.
Footnotes
References
- Brown B., (2017)., The Forward market in Foreign Exchange: A Study in Market-making, Arbitrage and Speculation Routledge
- CFA Institute,(2017)., CFA Program Curriculum 2018 Level I John Wiley & Sons
- Chisholm A., (2009)., An Introduction to International Capital Markets: Products, Strategies, Participants John Wiley & Sons
- Neftci S.,(2008)., Principles of Financial Engineering Academic Press
Author: Piotr Łabuz
