Finance 476. Forwards. Forwards. a forward contract is a contract to exchange two currencies in the future, at a rate that is set now. forwards are typically contracts between a firm wishing to hedge exchange rate risk, and the firm’s bank. Example :
Canadian firm is due to make a payment of $1,000,000 US to
an American supplier in 90 days. How many Canadian dollars
The payable will cost depends on the exchange rate in 90 days,
which is unknown. Therefore, the firm faces exchange rate risk.
When a firm hedges with a forward, it is getting rid of
possible downside risk, but also giving up potential for beneficial
movement in exchange rate.
German firm is due to receive $1,000,000 US in 30 days.
- spot rate = 1.1811 $US/€
- 30 day forward rate = 1.1801 $US/€
received by firm
Hedged with forward
spot rate in 30 days
Where f1 is the forward rate for 1 period from now and e and f
are in terms of units of domestic currency per unit of foreign
based on a 360 day year.