In 2021, an estimated $13.5 billion (£10.8 billion) was transferred in and out of the UK. For those transferring money internationally, an important consideration is whether exchange rate fluctuations may expose them to currency risk and lose them money on transactions.
One way to protect against this is by using a currency forward contract – an agreement that can lock in a current exchange rate for up to two years. This article explains how they work and how to use one to help protect your future transfers.
What is a forward contract?
A forward contract is a foreign exchange agreement that enables individuals or businesses to lock in a current exchange rate for a future transaction or transactions. Often referred to simply as the forward rate, this can be locked in for up to two years.
One advantage of a forward rate is that it enables you to make a clear budget plan because your future international payments will not be affected by exchange rate fluctuations.
For example, if you buy a property overseas, a foreign exchange (FX) forward contract allows you to fix the property price based on the exchange rate at the deposit stage. This is useful if the exchange rate becomes less favourable, because your price is locked in, so you don’t need to worry about market movements and can potentially save a lot of money.
When should you use a currency forward contract?
A forward exchange rate contract can be beneficial for major purchases such as:
- Overseas property purchase
- Overseas property maintenance
- Transferring savings when moving countries
- Regular or phased payments over time
- Overseas weddings
The impact of currency fluctuations
An FX forward contract can benefit these transactions because with larger sums of money, even a 1 per cent exchange rate fluctuation can significantly impact what you actually pay.
For example, imagine you are buying property abroad. In 2022, the value of the pound against the euro fluctuated between €1.2188 and €1.0843. That may not sound like much, but it means the real-term difference in price for a €400,000 property would be almost an additional £54,000. This could send the purchase out of your budget or at least cost you much more than you had planned.
By locking in a rate, you can avoid disappointment and accurately plan a budget by knowing exactly how much sterling will be leaving your account and how much foreign currency will be delivered.
Advantages of a currency forward contract
Pros
- Your fixed forward exchange rate will protect you from potential losses if the market drops dramatically.
- A currency forward contract provides certainty when transferring foreign currency – a significant advantage for large purchases or high-net-worth investors.
- It allows you to plan and predict cash flow and budgets more effectively by knowing exactly how much currency you will be buying or selling.
Cons
- Currency values go up as well as down. If the market moves in your favour after you have locked in an exchange rate with a forward contract, you cannot benefit from the new, better rate.
- Forward contracts are more complicated and require a legally binding agreement to create.
- Your personal preference might be to take the risk and watch the market in case it moves in your favour.
What is the difference between forward and current exchange rates?
The current exchange rate is the price of one country’s currency expressed in terms of another country’s currency. Forward exchange rates are based on the current exchange rate but adjusted for the interest rate differentials between the two currencies. Both parties are contracted to the forward exchange rate agreed at the time of the contract, which will remain fixed until either the rate is used for payment or the contract expires.
What is a forward contract vs a futures contract?
A forward contract is a private arrangement tailored to the needs of the individual, whereas a futures contract is traded with standardised terms on an exchange such as the London Stock Exchange.
Forward contracts protect against unfavourable currency market fluctuations when purchasing straightforward assets such as a property or a single expensive item. The arranged transaction and delivery are usually completed.
Futures contracts are often used by speculators who bet on price changes in the asset. They often never actually reach the delivery stage.
How do I know if a forward contract is right for me?
While a forward contract for foreign exchange protects you from losses, you may miss out if the currency’s value improves. If you prefer to take advantage of potential opportunities then other tools, such as market orders, may better suit your needs.
Where can I get a currency forward contract?
We have partnered with a foreign exchange service, Moneycorp, to offer you the Telegraph Media Group International Money Transfer Service. This service allows you to set up a forward contract for a future international payment, whether buying a holiday home, paying for a wedding abroad or funding your child’s overseas studies.
While currency market fluctuations are inevitable, a forward contract helps to mitigate the risk involved by protecting your budget and giving you stability.
Read more:
*Forward contracts may require a deposit
Be aware of currency risk.
None of the information contained in this article constitutes, nor should be construed as financial advice. TTT Moneycorp Limited (company number 738837) is registered in England. Its registered office is at Floor 5, Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ. Moneycorp is a trading name of TTT Moneycorp Limited which is authorised and regulated by the Financial Conduct Authority for the provision of payment services (firm reference number 308919). Date of approval XX/08/2023
Information correct at date of publication.
The above article was created for Telegraph Financial Solutions, a member of The Telegraph Media Group. For more information on Telegraph Financial Solutions click here.
