Outright Forward

An outright forward is a forward currency contract that locks in an exchange rate for a specific delivery date and a specific amount. An outright forward contract protects an investor, importer or exporter from changes in the exchange rates. Foreign exchange forward contracts can also be used to speculate in the currency market.

Companies that buy, sell or borrow from foreign businesses can use outright forward contracts to cover their exchange rate risk. For example, an American company that buys materials from a French supplier may be required to provide payment for half of the total value of the euro payment now and the other half in six months. The first payment can be paid for with a spot trade, but in order to reduce currency risk from the possible appreciation of the euro vs. the U.S. dollar, the American company can lock in the exchange rate with an outright forward purchase of euros.

The price of an outright forward is derived from the spot rate plus or minus the forward points calculated from the interest rate differential. The forward rate is not a forecast of where the spot rate will be on the forward date. A currency that is more expensive to purchase for a forward date than for spot is considered to trade at a forward premium; a currency that is cheaper for a forward date trades at a discount.

The spot foreign exchange market generally settles in two business days; the major exception is the Canadian dollar vs. the U.S. dollar, which settles on the next business day. Any contract that is longer than spot is considered a forward; most foreign contracts are for less than 12 months, but longer contracts are possible in the most liquid currency pairs.

The most actively traded currency pair is the euro vs. the U.S. dollar; the next most active are the dollar vs. the Japanese yen and the British pound.

An outright forward is a firm commitment to take delivery of the currency that was purchased and make delivery of the currency that was sold. The counterparties must provide each other with instructions as to the specific accounts where they take delivery of currencies.

An outright forward can be closed out by entering into a new contract to do the opposite; this can result in either a gain or loss vs. the original deal, depending on market movements. If the close-out is done with the same counterparty as the original contract, the currency amounts are usually netted under an International Swap Dealers Association agreement. This reduces the settlement risk and the amount of money that needs to change hands.