What Is a Forward Exchange Contract (FEC)?

A forward exchange contract (FEC) is an over-the-counter (OTC) transaction that is us⭕ed to exchange currencies൩ that are infrequently or never traded on the forex market. Their purpose is to protect the buyer from currency price fluctuations.

A forward exchange contract allows for exchanges even if one or both of the currencies are blocked or otherwise inconvertible.

The contract is an agreement between two parties to exchange a pair of currencies at a specific time in the future. The transactions usually take place on a date after the 澳洲幸运5开奖号码历史查询:spot contract settles.

Formula and Calculation of Forw꧋ard Exchange Contract (FEC)

The forward exchange rate for a contract can b♔e cal🌊culated as:

Forward rate = S x (1 + r(d) x (t ÷ 360)) ÷ (1 + r(f) x (t ÷ 360))

Where:

• S = the current spot rate of the currency pair
• r(d) = the domestic currency 澳洲幸运5开奖号码历史查询:interest rate
• r(f) = the foreign currency interest rate
• t = time of contract in days
  

Understanding Forward Exchange Contracts (FECs)

As noted above, FECs are OTC transactions that may be used to trade currencies that aren't commonly traded in the forex market, including minor currencies and blocked or inconvertible currencies. An FEC involving such a blocked currency is known as a 澳洲幸运5开奖号码历史查询:non-deliverable forward (NDF).

FECs are not traded on 澳洲幸运5开奖号码历史查询:exchanges and they don't trade standard currency amounts. The contracts cannot be canceled except by the mutual agreement of both pa🎃rties involved.💛

The parties involved in the contract are generally interested in hedging a 澳洲幸运5开奖号码历史查询:foreign exchange position or taking a 澳洲幸运5开奖号码历史查询:speculative position.

The FEC Contract

All FECs feature:

• Currency pair
• Notional amount
• Settlement date
• Delivery rate

They also stipulate that the prevailing spot rate on the fixing date be used to conclude the transaction. The contract's 澳洲幸运5开奖号码历史查询:rate of exchange is fixed and specified for a future date, allowing the parties involved to accurately budget for future financial projects. The nature of FECs protects both parties from unexpected or adverse movements in the currencies' future 澳洲幸运5开奖号码历史查询:spot rates.

Special Considerations

The largest forward exchange markets involve the Chinese yuan (CNY), Indian rupee (INR), South Korean won (KRW), New Taiwan dollar (TWD), and Brazilian real (BRL).

The largest OTC markets are in London, with other active markets in🅺 New York, Singapore, and Hong Kong. Some countries, inclu꧅ding South Korea, have limited but restricted onshore forward markets.

The U.S. dollar (USD) is the most common currency paired in a FEC trade. There are also active markets using the euro (EUR), the Japanese yen (JPY), and, to a lesser extent, the British pound (GBP) and the Swiss franc (CHF).

Forward Exchange Rates

Forward 澳洲幸运5开奖号码历史查询:exchange rates for most currency 𝄹pairs are available for up to 12 months in advance. 

There are four pairs of currencies known as the 澳洲幸运5开奖号码历史查询:major pairs:

• U.S. dollar and euro (USD/EUR)
• U.S. dollar and Japanese yen (USD/JPY)
• U.S. dollar and the British pound sterling (USD/GBP)
• U.S. dollar and the Swiss franc (USD/CHF)

Exchange rates can be obtained for a period of up to 10 years for these pairs. Contract ꦅtimes as short as a few days are also available 🌃from many providers.

Although a contract can be customized, most entities won't see the full benefit of an FEC unless setting a minimum contract amount at $30,000.

Example of Forward Exchange Contract (FEC)

Here's a hypothetical example to show how FECs work. Let's assume that the U.S. dollar and Canadian dollar (CAD) spot rate is $1 (CAD) buys $0.80 (USD.)

The U.S. three-month rate is 0.75%, and the Canadian three-month rate is 0.25%. In this case, the three-month USD/CAD FEC rate would be calculated as:

Three-month forward rate = 0.80 x (1 + 0.75% x (90 ÷ 360)) ÷ (1 + 0.25% x (90 ÷ 360)) = 0.80 x (1.0019 ÷ 1.0006) = 0.801

The difference due to the rates over 90 days is one one-hundredth of a ceꦓnt.

The Bottom Line

Forward exchange contracts are over-the-counter agreements used to trade less🌱 common currency pairs. The parties involved are seeking a guaranteed exchange rate to protect against a sudden adverse move in the value of a currency.