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FORWARD CONTRACTS
Forward currency contracts are a popular investment vehicle used for hedging against future changes in
exchange rates. An investor (or any other party or institution) with a known obligation to provide funds
in a foreign currency at a future date (for example, to pay for imported goods scheduled to be delivered
in several weeks) may be motivated to buy forwards to lock in the cost of the future obligation.
Forwards are sold for only a few currencies and are sold at a premium or discount relative the current
spot price.
1. Currencies: The currencies that have forward contracts available are the Canadian dollar (C$),
Japanese yen (¥), Swiss franc (SF), and the UK pound (£). Within each of these currencies, there are 1
month, 3 month, and 6 month forwards available. That is, the currency delivery date is one month (or 3
or 6 months) from the date of purchase.
2. Premiums (discounts): For a given currency, for example the Swiss franc, the forwards may be
selling at premium or discount to the recent market or spot price. The forward prices are set by supply
and demand and change based on currency traders' aggregate assumptions regarding future exchange
rates between, in this case, the US dollar and the Swiss franc. A clipping from the 8 July 2009 issue of
The Wall Street Journal from their table called "Currencies July 7, 2009 U.S. –dollar foreign-exchange
rates in late New York trading" shows in part the following:
Switzerland franc
1-mos forward
3-mos forward
6-mos forward
.9177
.9180
.9188
.9203
The first quote is the spot price of the SF (from the day before) and is in US$ , or number of US$ to buy
one Swiss franc, ($/SF). The 6-mos forward is selling at a premium over the spot, and this is generally
expressed as a percentage. (.9203 - .9177) / .9177 = 0.00283317 or "the 6-mos forward is selling at a
.28% premium". Forwards selling at a premium reflect the widely held assumption that the value of the
currency (the SF in this case) is more likely to rise than to fall in relation to the US dollar over the next
few months.