A Forward Contract is an agreement between two parties to buy or sell something at a fixed price on a future date. The terms are agreed when the contract is made.
In international trade, forward contracts are often used to manage currency risk. An exporter can fix an exchange rate in advance and avoid the impact of an unfavourable currency movement later.
How It Works:
- Two parties agree on a price and future date.
- The contract locks in the price in advance.
- Market prices may change over time.
- On the agreed date, the transaction is completed at the fixed price.
Benefits:
- Protects against price fluctuations
- Helps in financial planning
- Reduces risk in international trade
- Useful for currency and commodity hedging
Example:
An Indian exporter expects to receive $50,000 after three months. The exporter enters into a forward contract with a bank to fix the exchange rate today. This gives the exporter more certainty about how much the payment will be worth in Indian rupees.