4NX Forward Contracts
Forward Contracts protect your bottom line against movements in the foreign currency market. Forwards enable you to lock in exchange rates up to a year in advance and they are an excellent hedging tool for clients who want to lock in exchange rates today for payments that won't have to be settled for several months.
Whether you want to lock in budget projections or you're planning your price point for a brochure, unfavorable market movements can derail your plans. Forward contracts protect you from potentially adverse market volatility.
FORWARD CONTRACT SCENARIOS
You are a British importer signing a contract in March to buy 4 containers of Spanish China over a 4 month period. The containers will be arriving monthly, and you will have to pay 100,000.00 euros per container. At the time you sign the contract, you use an exchange rate of 0.67 to predict your costs. You expect you will pay £67,000.00 per container.
You sign the contract, and you set your retail prices based on your cost, and have brochures printed. Perhaps you believe you can sell each container full of merchandise for £76,000.00. You look forward to £9,000.00 revenue per container.
If you buy a forward contract for each of those twelve payments, whatever fluctuations happen in the currency market will not affect you. You have fixed your costs.
If you have not locked in your cost through a forward contract and the Pound weakens to 0.69 your container goes from costing £67,000.00 to £69,000.00. Suddenly your revenue per container has shrunk by almost 25%. What if the rate goes to 0.76? You are then only breaking even — Forward Contracts protect you from this kind of negative market change.
ARE FORWARDS CONTRACTS RIGHT FOR YOU?
It is also possible that the rate in our example could have gone from 0.67 to 0.65. If you have not locked into forward contracts your profit jumps from £9,000.00 per container to £12,000.00 per container.
The importer who locked in forward contracts is still only making £9,000.00 per container. If it was you in this scenario, which would you prefer — the peace of mind that comes from locking in your profit even if you close the door to potential gains due to foreign exchange activity? Or would you prefer to wait it out and see if you can make even more profit by riding the market. Forward contracts may or may not be right for you, they are a commercial decision based upon the information available and market conditions at the time.
Your Account Executive can review different scenarios for you and show you the pros and cons of forward contracts so that you can decide if this is a risk management tool you would like to incorporate into your foreign exchange business plan.
