A forward contract in forex is a private agreement to exchange one currency for another at a rate agreed today, with settlement on a specified future date. Unlike a spot trade, which settles in a couple of business days, a forward lets you lock an exchange rate now for a payment or receipt that will happen weeks, months or even years ahead. For businesses and traders who need certainty about future cash flows, forwards are a common hedging tool; for speculators they are a way to take a view on future currency moves without using standardized exchange-traded instruments.
How a forex forward actually works
When two parties enter a forward they agree four basic things: which currency pair, the notional amount, the settlement (or delivery) date, and the forward rate. The contract is negotiated over the counter (OTC), typically between a corporate and a bank or between two financial institutions; because it is bespoke, the amount and date can be tailored to the parties’ needs.
At inception there is usually no exchange of the full notional amounts — the contract is a promise to exchange them on the agreed future date. If both parties hold to the agreement, the currencies are swapped at the agreed rate on settlement. In many cases the contract can be closed out beforehand by entering an offsetting forward with the same counterparty, but that process may require negotiation and can involve additional costs.
What determines the forward rate
The forward rate is not simply a prediction of where the spot will be in the future. Its price is linked to the current spot rate and the interest-rate relationship between the two currencies, a relationship commonly summarised by covered interest rate parity. In simple terms, currencies with higher interest rates tend to trade at a forward discount versus currencies with lower interest rates, and vice versa. That reflects the cost (or benefit) of holding one currency versus the other over the contract period.
A straightforward way to think about the calculation is to adjust the spot rate by the relative interest earned in each currency over the contract’s life. If you denote the current spot rate by S, the domestic interest rate by r_dom, the foreign interest rate by r_for, and the time to settlement as a fraction of a year t, a commonly used approximation is:
Forward rate ≈ S × (1 + r_dom × t) ÷ (1 + r_for × t)
This formula converts the spot price into a forward price by accounting for how much each currency would grow or cost to borrow over the time to settlement.
A concrete example
Imagine a U.S. company expects to receive 1,000,000 Canadian dollars in 12 months and wants to lock the USD equivalent today. The current spot is 1 USD = 1.0500 CAD. Suppose the one-year USD deposit rate is 1.5% and the one-year CAD rate is 3.0%. Using the simple adjustment above with t = 1 year:
Forward (USD/CAD) ≈ 1.0500 × (1 + 0.015) ÷ (1 + 0.03)
Forward ≈ 1.0500 × 1.015 ÷ 1.03 ≈ 1.0357 CAD per USD
That forward rate implies fewer Canadian dollars per US dollar in a year compared with spot today; in practice the U.S. company would use this rate to fix the USD value of the future CAD receipt. If the actual spot in 12 months is worse for the company, the forward achieves its hedging goal; if the spot is more favourable, the company misses out on potential gain because the forward is binding.
Deliverable vs non-deliverable forwards
Most forwards result in delivery of the currencies on the settlement date, and the parties exchange the agreed notional amounts. For some currencies that are restricted or not freely convertible, market participants use non-deliverable forwards (NDFs). An NDF is settled in a convertible currency (often USD) by paying the net difference between the contracted forward rate and the prevailing spot on the fixing date, rather than exchanging the underlying local currency. NDFs are a cash-settled version of forwards used to provide hedging where physical settlement is impractical or prohibited.
Why firms and traders use forwards
Companies that have receivables or payables in foreign currencies use forwards to remove the uncertainty of future exchange rates and budget reliably. For example, an importer who must pay a supplier in euros in six months can lock the euro cost today, avoiding the risk of a weaker domestic currency. Traders may use forwards to position for longer-term moves or to gain exposure without the daily margining of exchange-traded futures.
Forwards are attractive because they are flexible: the size, settlement date and terms can be matched to actual business needs. That flexibility is the main practical advantage over standardized futures contracts.
How forwards differ from futures
Forwards trade over the counter, are customizable and typically settle once at maturity. Futures are standardized contracts traded on exchanges and are marked to market daily with variation margin. That daily settlement reduces counterparty credit exposure in futures markets because an exchange’s clearinghouse stands between the buyers and sellers. By contrast, forward contracts expose participants to the credit risk of their counterparty because there is no central clearing unless the parties agree otherwise.
Practical steps to enter a forward (overview, not advice)
A typical process starts with a client contacting a bank or FX provider, stating the currency pair, amount and settlement window they need. The provider quotes a forward rate based on spot, interest-rate differentials and the chosen maturity. Once both parties agree, they sign the contract and the trade is booked. Depending on the provider and the trade size, margin or credit terms may be required, and the provider will monitor the contract until settlement.
Risks and important caveats
Forward contracts remove exchange-rate uncertainty but introduce other risks that you should understand. Because forwards are OTC, there is counterparty risk — the chance the bank or client may default when the contract matures. For long-dated forwards, market conditions can change dramatically, and the contract may prevent you from capturing favourable moves in the spot market. Liquidity can be limited for some currencies or specific maturities, which can widen pricing or make it hard to close a position before maturity. Non-deliverable forwards expose you to settlement in a third currency and to legal or regulatory restrictions in the local market. Finally, some providers require collateral or margin; adverse moves can trigger margin calls that affect cash flow. Trading carries risk and this article is for general information only; it is not personalised advice.
When forwards may be appropriate — and when they may not
Forwards tend to suit companies and investors who prioritise certainty of future cash flows and who deal with sizable amounts where the cost of a forward is justified. They may be less suitable for small retail traders because OTC forwards often have minimum sizes and because retail platforms usually offer other instruments (such as futures, options or spot contracts) that better match their needs and risk appetite. Always consider counterparty creditworthiness, contract terms, and alternative hedging tools before deciding.
Key Takeaways
- A forex forward locks an exchange rate today for currency exchange at a specified future date; contracts are OTC and customizable.
- Forward pricing reflects the spot rate adjusted for the relative interest rates of the two currencies, not a prediction of the future spot.
- Forwards are useful for hedging predictable future receipts/payments but carry counterparty, liquidity and opportunity-cost risks.
- Trading carries risk; this information is educational and not personalised financial advice.
References
- https://www.investopedia.com/terms/f/forward-exchange-contract.asp
- https://www.chathamfinancial.com/insights/what-is-an-fx-forward
- https://www.ig.com/uk/forex/what-is-forex-and-how-does-it-work/forex-forwards-explained
- https://en.wikipedia.org/wiki/Forward_contract
- https://deal.tdsecurities.com/tdfx/assets/docs/Spot_and_Forward_Contracts.pdf
- https://www.stonex.com/en/financial-glossary/fx-forwards/
- https://www.forex.com/en-us/glossary/forward-contract/
- https://www.investopedia.com/terms/c/currencyforward.asp
- https://corporatefinanceinstitute.com/resources/foreign-exchange/currency-forward/