An FX forward is shorthand for foreign exchange forward. A foreign exchange forward is a contract with a bank to exchange cash in one currency for cash in another currency at a future date. Companies use foreign exchange forward to hedge losses and as a speculative investment.
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Determine the details of the contract. For example, Firm A enters into a foreign currency forward contract. In on month, Firm A will exchange £650 for 1,500 euros. The current exchange rate is one dollar for 1.25 euros. The exchange rate in one month ended up being one dollar for 1.6 euros. Firm A entered into the foreign currency forward because in one month, they owe 1,500 euros to Firm B, a German company.
Exchange the currency. In the example, Firm A would give the bank £650. The bank will give Firm A 1,500 euros.
Determine the gain or loss. In our example, Firm A pays £650 for 1,500 euros. If Firm A did not enter the foreign currency forward contract, then it would need to pay £609.3 to get 1,500 euros today. To calculate this, divide £975 by 1.6 euros. The 1.6 euros is the current exchange rate when the contract is due, as noted in Step 1. Since the company paid £650 for the 1,500 euros, it would have lost £40.60.
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