A forward FX contract is a deal to exchange currencies - to buy or sell a particular currency - at an agreed date in the future, at a rate - a price - agreed now. This rate is called the forward rate. Banks will provide forward FX quotes on more or less any currency pair.

Forward value dates are calculated out of spot value dates, which are in turn calculated out of the transaction date. As we have seen, the spot value date is two business days after the transaction date.

So for a 1month forward deal struck on Wednesday 3 March 2000: spot value is Friday 5 March - forward value is Monday 5 April.

Traditional FX forwards are available for maturities from 3 days out to about 2 years. As such, forward FX is the over-the-counter (OTC) equivalent of currency futures. Both contract types allow transactors to take a view on the direction and extent of future spot FX rates.

Speculation and hedging

Forward fx contracts have two broad uses: speculation and hedging.

Pure speculators are more likely to use currency futures to take a straight, directional view on future exchange rates in major currency pairs. This is because the exchange-traded futures market allows positions to be highly leveraged and the standardised contracts (price, size, maturity) create the liquidity to allow speculators to trade contracts before their expiry date.

The limited number of currency pairs available, and their standard size and limited settlement dates are factors which all contribute to the liquidity of futures contracts and make them attractive to speculators. However, these are the very qualities that make currency futures unattractive to clients wishing to hedge a precise currency exposure.

Forward FX is the product of choice for currency hedgers. These hedgers fall into three broad categories.

1. Corporate and retail clients with underlying business reasons to use FX are typically risk averse. They like the comfort of a fixed future revenue stream from international transactions. For example, when a UK corporate will receive USD in 30 days time, the future value of that USD in terms of GBP can be fixed now by entering into a forward FX deal with a bank to sell it USD for GBP in 30 days time at a pre-agreed rate.           
2. International portfolio managers may also use forward FX for much the same reason - to secure the value of future investment returns (e.g. foreign currency denominated bond coupon payments).      
3. Banks use forward FX contracts mainly for liquidity management. They combine a forward FX trade with a spot FX trade to create a two-leg deal called an FX swap.