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Forward Exchange Contract

A forward exchange contract (FEC) is a special type of over-the-counter (OTC) foreign currency (forex) transaction entered between two parties to exchange a pair of currencies at a specific time in the future. These transactions typically take place on a date after the date that the spot contract settles and are used to protect the buyer from fluctuations in currency prices.

Understanding Forward Exchange Contracts (FECs)

Forward exchange contracts (FECs) are not traded on exchanges, and standard amounts of currency are not traded in these agreements. Still, they cannot be cancelled except by the mutual agreement of both parties involved.

The parties involved in the contract are generally interested in hedging a foreign exchange position. All FECs set out the currency pair, notional amount, settlement date, and delivery rate, and stipulate that the prevailing spot rate on the fixing date be used to conclude the transaction.

The contract's rate of exchange is thus fixed and specified for a specific date in the future, allowing the parties involved to better budget for future financial projects and know in advance precisely what their income or costs from the transaction.

Objective
The purpose of an FX forward is to lock in an exchange rate between two currencies at a future date to minimize currency risk. This might be done, for instance, if a company is contractually obliged to pay a set amount for the future delivery of goods in a foreign currency and wishes to lock in the rate.

Advantages
Provides certainty to the buyer regarding the cost of a future purchase
A FX forward can be tailored to the exact requirements of the client

Disadvantages
Clients are bound to honor the contract and cannot benefit from advantageous movements in currency prices
Should the market move against the client, bank or broker, margin requirements may adversely impact the borrower’s cash flow

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