Hedging made easy with forward foreign exchange contracts

As the old saying goes, expect the unexpected. In financial markets, you always have to expect uncertainty but that doesn’t mean you can’t mitigate your risk. Discover how OFX’s hedging strategies and use of forward contracts can help you protect your business against the risk of currency fluctuations with simple, reliable strategies.

What is a forward contract?

Forward contracts, also referred to simply as forwards, are a buy now pay later option for businesses trying to take advantage of a favorable rate today on a payment that needs to be paid in the future. This means that you have secured protection against changes in currency rates, a way to limit the impacts of FX moves on your profits, and elimination of currency risk. This hedging practice prevents the risks and uncertainties associated with a volatile market.

Types of forwards

There are two types of forwards used in foreign exchange. The first is a fixated forward, this type sets a specific time in the future when the forward contract will be fulfilled. The second is a window or open-dated forward. A window forward is when you choose a window of time when you can exchange money at the agreed-upon rate, with this type of forward you can move portions of money at any time in that window.

Why use forwards for hedging?

So, you might be asking, what’s the point? Why don’t people either just complete their exchange now or wait until they are ready to exchange currencies? A forward lets you lock in your exchange rate for up to 12 months with no worries and no surprises as you know the rate you have is locked in. These contracts and hedging in general were  born out of necessity for people wanting to plan ahead and avoid volatility in the market. “People use forwards to mitigate risk. Forward contracts are a planning tool and are in no way a bet or a risk,” Director of FX Risk Management, Jean-Francois Giguere said.

A forward contract in real life 

To understand forwards in context, let’s use Kathy as an example. Kathy owns a clothing store and sources international pieces, meaning she needs to exchange USD for other currencies. Kathy exchanges with OFX regularly and she knows a big order of spring clothing is coming up in May. She is looking for the right time to exchange for the best rate. Kathy is nervous because the market outlook is unsteady, she would rather get the current rate than wait to see what the exchange rates are in May. Kathy discusses this idea with her OFXpert and her OFXpert suggests a forward contract. Kathy’s OFXpert explains that Kathy and OFX will set a contract with an identified rate of exchange at a set time when Kathy will exchange her money. This would specify a time at the beginning of May so Kathy can purchase her products. This helps Kathy prepare for this large purchase by knowing exactly how much she will spend on the new products with her definitive exchange rate in the forward contract. Kathy loves the idea of being able to plan out her finances instead of waiting on an uncertain market.

Myths about forwards and hedging 

There are many myths about using forwards and hedging. Some people shy away from hedging because they don’t want to “guess” about the strength of the market or a currency in the future. “Many people I discuss forwards with say that they don’t want to speculate so they won’t use a forward contract. This is a myth about forwards because they are not speculative at all, they help you plan and mitigate market volatility risks. In fact, the speculative nature of the market would be future spot transactions,” Head of North American Sales, Jacob Scriven said.

The difference in OFX’s forward contracts

The logistics of a forward are universal meaning forward contracts with a bank and with an FX provider are the same however, the difference with us is our OFXperts. “We are different because of our human plus digital aspect. Your OFXpert, someone who actually knows you and your business, is going to help you strategize when is the best time for you to use a forward,” Malak said.

What are the risks of using forwards?

While forwards have mostly upsides, in a volatile market there can also be risks. If you sign a Forward Contract it prevents you from taking advantage of beneficial movements. If a currency pair you are interested in trading moves in a more profitable way for you, you will not be able to take advantage of that better rate because you are bound by the forward. To avoid situations like these some people use a forward for a portion of their total payment which both hedges against volatility and is still open to a beneficial rate down the line. 

What other risk mitigation tools are out there?

OFX offers several risk mitigation tools to help you navigate perpetual market volatility. 

  • Limit Orders – are another risk management option that allows you to set the rate you are comfortable with and, once the exchange rate hits that point, your OFXpert will get in touch to let you know that it’s time to complete your transfer! 
  • Currency Outlook – Our weekly and monthly currency outlook compiles our treasury expert’s outlook in combination with key currency shifts and global news to lay out a comprehensive look into projected currency fluctuations.
  • Risk Calculator – Use our calculator to determine the impact shifting market exchange rates could have on an example invoice. This is not a quote, it’s designed to help you understand the impact of currency fluctuations.
  • Rate Alerts – Stay on top of moving markets with OFX rate alerts. Get personalized market rate alerts direct to your inbox. If you don’t have time to be your own currency strategist, our rate alert option allows you to set a target market rate and our currency experts will monitor the ever-changing market for you.

Whether you are a small business owner, a CFO at a large company, or an online seller, forwards can help you plan for the future, mitigate FX risks, and get an exchange rate you are comfortable with. Interested in speaking to an OFXpert about forwards? Contact us today!

Fix your rate to protect against market moves

Create currency confidence and stay ahead of market moves with OFX’s forward contract hedging tools.

Navigate rate swings in turbulent times. Our OFXperts can help you make more informed decisions about hedging and risk mitigation. Contact us.

IMPORTANT: The contents of this blog do not constitute financial advice and are provided for general information purposes only without taking into account the investment objectives, financial situation and particular needs of any particular person. UKForex Limited (trading as “OFX”) and its affiliates make no recommendation as to the merits of any financial strategy or product referred to in the blog. OFX makes no warranty, express or implied, concerning the suitability, completeness, quality or exactness of the information and models provided in this blog.