Forward Contracts

1. Basic forward contract

A forward contract guarantees a foreign exchange rate for a future date for any period from three days to one year. This rate is fixed irrespective of currency movements between when the rate is agreed (the deal date) and when the funds are transferred (the settlement date). No payment is made until the settlement date, except for a deposit which is required to hold the rate.

This type of contract is ideal if you want to fix a rate now but will not be making immediate payment. A forward contract is fixed at the 'forward rate' which usually differs from the rate for immediate transfer, or 'spot rate'.

The difference between the two rates is due to the 'forward points'. The forward points are a calculation of the difference in the interest rates between the two currencies and the time period. This is most easily explained with an example.

Example: On 19 September 2008, UK interest rates were 5% and European interest rates were 4.25%. The difference is 0.75%. If you wanted to book a one year forward contract, i.e. fix the exchange rate for 19 September 2009, we would reduce the exchange rate by approximately 0.75%. Although the exchange rate appears worse for the person holding sterling for a year, they are exactly compensated by earning more interest in the UK. The calculation is always approximate because the forward points are calculated using predicted interest rates as opposed to actual interest rates. If your forward contract was only three months ahead, you would simply divide the interest rate difference (or one year forward points) by four. You can calculate the approximate forward rate for any forward date pro-rata using the number of days divided by 365.

2. Flexible forward contract

This allows you to fix the exchange rate for a future date but with the following choices:

1. Change the settlement date

This allows you to make and receive the pre-agreed payments early or move the date further into the future. Thus, even if you don't know the completion date of your property or purchase order, but wish to fix the exchange rate now, you can set a target date and adjust it once you know the final date. The underlying 'spot rate' is unchanged if you adjust the date but the forward points may be adjusted using the same formula as above. This means that any adjustments in the forward date may affect your exchange rate, depending on the currency you're purchasing and the predicted interest rates

2. Draw down facility

This allows you to make multiple payments on different dates drawing down from one lump sum. Therefore if you need to make instalment payments on a property or purchase order and wish to fix the exchange rate for all of your payments you can.

Deposits

Due to the increased risk to World First of fixing a rate in advance without immediate payment, we ask clients for a deposit when entering into a forward contract. The deposit requirements are detailed below:

In certain circumstances lower deposit rates can be agreed. When entering into a forward contract you must accept we may need to make a 'margin call' if the deposit is utilised, e.g. if the rate is set at 1.26 and a 10% deposit is taken. If the rate moves over 1.3860 (an increase of 10%), World First is at risk on the contract because if you breach the contract, we will lose more than the deposit held. In this instance we would ask for a further small deposit to continue to hold the rate.

Additionally, we usually ask for a higher deposit if the currency you are purchasing is particularly volatile e.g. South African Rand.

See our glossary for further information or contact us to discuss your individual needs.