Forward exchange contract

A forward exchange contract (FEC) is a special type of over-the-counter (OTC) foreign currency (forex) transaction entered into in order to exchange currencies that are not often traded in forex markets. These may include minor currencies as well as blocked or otherwise inconvertible currencies.

1. What are advantages of forward exchange contracts?
2. What are the features of forward exchange contract?
3. How do you account for forward exchange contracts?
4. How do forward contract work?
5. Is forward contract an asset?
6. Does foreign currency hedging pay off?
7. What is the difference between forwards and futures?
8. Who enters into forward contracts?
9. Are forward foreign exchange contracts derivatives?
10. Do forward contracts require margin?
11. Do forward contracts have a premium?

What are advantages of forward exchange contracts?

A forward contract allows you to fix a prevailing rate of exchange for up to two years. (A forward contract may require a deposit.) Exchange rates can fluctuate by as much as 10% or more over periods of extreme volatility, so the cost in dollars can be significantly impacted.

What are the features of forward exchange contract?

The main features of forward contracts are: * They are bilateral contracts and hence exposed to counter-party risk. * Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. * The contract price is generally not available in public domain.

How do you account for forward exchange contracts?

A forward contract allows you to buy or sell an asset on a specified future date. To account for one, start by crediting the Asset Obligation for the current value of the good on the liability side of the equation. Then, on the asset side, debit the Asset Receivable for the forward rate, or future value of the good.

How do forward contract work?

A forward contract is a customizable derivative contract between two parties to buy or sell an asset at a specified price on a future date. ... For example, forward contracts can help producers and users of agricultural products hedge against a change in the price of an underlying asset or commodity.

Is forward contract an asset?

Since the forward contract refers to the underlying asset that will be delivered on the specified date, it is considered a type of derivative. They are complex financial instruments that are. Forward contracts can be used to lock in a specific price to avoid volatility.

Does foreign currency hedging pay off?

Funds that use currency hedging believe that the cost of hedging will pay off over time. The fund's objective is to reduce currency risk and accept the additional cost of buying a forward contract.

What is the difference between forwards and futures?

A forward contract is a private and customizable agreement that settles at the end of the agreement and is traded over the counter. A futures contract has standardized terms and is traded on an exchange, where prices are settled on a daily basis until the end of the contract.

Who enters into forward contracts?

The two parties typically enter into a forward contract because of their opposing views on a particular asset. One party believes that the price of a particular asset is set to rise in the future and therefore wishes to purchase it at a lower, predetermined price to make his profit.

Are forward foreign exchange contracts derivatives?

A forward contract is a customized derivative contract obligating counterparties to buy (receive) or sell (deliver) an asset at a specified price on a future date. ... In forex markets, forwards are used to exploit arbitrage opportunities at the cost of carrying different currencies.

Do forward contracts require margin?

Since futures contracts are traded on formal exchanges, margin requirements, marking to market, and margin calls are required; forward contracts do not have these requirements. The purpose of these requirements is to ensure neither party has an incentive to default on their contract.

Do forward contracts have a premium?

A forward premium is frequently measured as the difference between the current spot rate and the forward rate, so it is reasonable to assume that the future spot rate will be equal to the current futures rate. ... If the forward exchange rate for a currency is more than the spot rate, a premium exists for that currency.