Forward Contract

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A forward contract is an agreement between two parties to exchange a good at a future date at an agreed price. A very common, but not universal, meaning of the term is where a business will enter into a forward contract with a bank to purchase a foreign currency on a future date.

Suppose a United States company is going to import a product from Canada. Delivery is expected in three months, with payment due to the supplier thirty days after. The importing US company may enter into a forward contract to purchase the required amount of Canadian dollars in four months. This protects the importing company from the risk of a rising Canadian dollar during the period between contract agreement and payment due. However, it will also prevent any unexpected profit that would occur in the same period were the Canadian dollar to fall.

There is no secondary market for forward contracts. The price of foreign currency contracts is determined mathematically based on the difference in interest rates between the two countries.