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 Forward exchange contract 

What is it?

A forward exchange contract—also called a forward currency contract—is an agreement between you and your bank in which the bank agrees to buy or sell a certain amount in a foreign currency at a fixed rate of exchange on, or during a period up to, a particular date.

As an exporter entering an export contract in a foreign currency, a forward exchange contract allows you to determine at the time you sign the contract the exchange rate which will apply to future payments from your buyer.

How does it work?

In a forward exchange contract, your bank quotes a forward exchange rate for buying a specified foreign currency from you and for paying you in Australian dollars.

A fixed forward exchange contract states the type and amount of foreign currency the bank will buy, the agreed exchange rate and the specific date on which you’ll pay the foreign currency to the bank.

A forward option contract states a period of time, rather than a specific date, during which the bank will exchange the foreign currency for Australian dollars.

Your bank may quote different exchange rates in a fixed forward exchange contract and a forward option contract.

The term of a forward exchange contract can range from a few days to more than 12 months.

A forward exchange contract can state a series of agreed exchange dates, with corresponding exchange rates, in order to match the payment dates under your export contract (for example, if you’re receiving payments from your buyer in instalments).

If you have several export sales contracts in a particular foreign currency, a forward exchange contract can cover payments under all of those contracts.


The diagram below shows a typical fixed forward exchange contract.

 

Notes to diagram

  1. You enter into an export contract with your buyer which states that on a specified payment date, the buyer will pay you in a currency other than Australian dollars (AUD).
  2. You enter into a forward exchange contract with your bank: an agreement that on the payment date, the bank will buy the foreign currency you receive from the buyer at a fixed exchange rate.
  3. You provide goods or services to your buyer in accordance with the export contract.
  4. You send the buyer an invoice for payment in foreign currency.
  5. The buyer pays you in foreign currency.
  6. You pay the foreign currency to the bank.
  7. The bank pays you the AUD equivalent at the agreed exchange rate.

What are the pros and cons?

Pros Cons
Allows you to manage the risk of exchange rate movements between the currency of your export contract payments and Australian dollars If your buyer doesn’t pay you on time under your export contract, your bank will still expect you to fulfil the forward exchange contract by exchanging the amount of the export contract payment for Australian dollars on the agreed date

What costs are involved?

Bank fees or charges for a forward exchange contract vary depending on the terms of your agreement with the bank.

 

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