Rather than just sitting down and writing what we think a 'Forward' contract is and how you might go about using one to best effect, as you might expect and in an attempt to flesh out our more colloquial references to them, we have done some research.
We've looked at how others describe them... What regulators think of forward contracts and what they think are their associated risks and benefits; and we have also looked at how our current clients implement it/them in the course of their day to day currency activities and longer term risk and payment strategies.
So, in tried and tested GCSE fashion, let's begin with the online definition:
"A forward contract is an agreement between two parties giving the buyer an obligation to purchase an asset (and the seller an obligation to sell an asset) at a set price at a future point in time."
1) It is a customised contract between two parties to buy or sell an asset at a specified price on a future date.
2) It can be used for 'hedging' or speculation, although its non-standardised nature makes it particularly apt for hedging.
Unlike standard futures contracts, a forward contract can be customised to any commodity, amount and delivery date.
3) A forward contract's 'settlement' can occur on a cash or delivery basis. Forward contracts do not trade on a centralised exchange and are therefore regarded as over-the-counter (OTC) instruments.
4) While their OTC nature makes it easier to customise terms, the lack of a centralised clearing house also gives rise to a higher degree of default risk. As a result, forward contracts are not as easily available to the retail investor as futures contracts.
Whilst you may have understood the check list above, not only does it bear repeating, but, some of what is said could stand to be translated into common English.
We added in the numbers in above list so that we can systematically go through each number and provide you with the explanation that might be relevant to how you could use a forward.
1) Customised means that the date on which someone pays for the forward is not arbitrarily agreed between the seller and the buyer. It is not a set or conventionally understood length of time - like a spot contract might be. Also, arrangements for margin or deposits is bespoke to the forward prior to booking it.
You (the client) set the date you want to complete a forward, but, you can also include provisions to shorten the contract term/length if you want to.
So, someone buying a house in France might set their forward maturity date a whole month later/after the completion date for the purchase just in case something meant they could not meet the completion deadline, as a precaution. Ensuring you use the right forward, you're not tied to that date 4 weeks later, but can shorten the contract length so as to take receipt of your currency on the day of completion or a fraction before if you wish - you've customised the contract to reflect the fact that you might want to close it off early.
Think of it like your forward buys a pot of currency. The terms of the forward means you can take out funds from the pot over the period of the forward until the currency is gone.
If you do not take funds from that pot then when the maturity date comes around you have the whole sum to do with as you will.