With this currency forward calculator, you can easily calculate the currency forward price - the price of a currency forward contract. A currency forward contract is a commonly used derivative of the hedge currency exposure.

This article will help you understand what is a currency forward contract and how to calculate the current forward price. We will also demonstrate some examples to help you understand the concept.

What is a currency forward contract?

Currency forward is essentially an agreement that allows you to buy or sell your currency at hand at a fixed currency exchange rate in the future. The price of the currency forward is determined using the interest rate parity between the two currencies, which we will explain in the section below.

There are 2 main benefits of using currency forward instead of currency future. First, unlike currency futures which have fixed and standardized terms, currency forward allows parties to tailor the agreement to fit their specific needs. Second, currency forwards do not require you to pay an upfront payment to enter into the agreement.

How to calculate the currency forward price?

Now, we can discuss the calculation of currency forward price. Let's take the currency forward between GBP/MYR as an example. GBP stands for the British pound sterling, and the MYR stands for Malaysian ringgit.

  • Currency forward: GBP/MYR;
  • Number of days in the forward contract: 90 days;
  • Price currency: GBP;
  • Base currency: MYR;
  • Annualised price currency interest rate: 0.8%; and
  • Annualised base currency interest rate: 3.2%.

Evaluating the currency forward price requires 4 steps:

  1. Estimate the price currency interest rate

The calculation of the price currency interest rate involves adjusting its annualized interest rates. We can easily find most annualized currency interest rates on the market. The price currency in this example is GBP, and the annualized interest rate for GBP is 0.8%.

We can calculate the price currency interest rate using the formula below:

price currency interest rate = annualised price currency interest rate * (days / 360).

Hence, the price currency interest rate for this currency forward interest rate is 0.8% * (90 / 360) = 0.2%.

  1. Calculate the base currency interest rate

Similarly, we need to adjust the annualized base currency internet rate. The base currency for this example is MYR, and the annualized interest rate for MYR is 3.2%.

We can work out the base currency interest rate using the formula below:

base currency interest rate = annualised base currency interest rate * (days / 360)

Hence, the base currency interest rate for this currency forward interest rate is 3.2% * (90 / 360) = 0.8%.

  1. Determine the current spot price

You can find the current spot price easily by just googling it or through some financial data websites such as Xe.

The current spot price for GBP/MYR is 0.1735.

  1. Calculate the currency forward price

The final step is to evaluate the currency forward price using the following formula:

currency forward price = spot price * (1 + price currency interest rate) / (1 + base currency interest rate)

For our GBP/MYR currency forward contract, its price is 0.1735 * (1.002 / 1.008) = 0.1725.

The real-life application of the currency forward contract

There are 3 main usages of a currency forward contract:

  1. Currency forward contract can be used in hedging.

A company can hedge its foreign currency exposure by engaging in currency forward contracts. For example, suppose a company needs to exchange GBP 1,000,000 to MYR in 1 year. To ensure that the transaction will not be affected by the development of the currency spot rate, the company can engage in a currency forward contract and lock in a particular currency exchange rate.

By doing this, the company eliminates any risks associated with negative currency movement. However, it also forgoes some potential profit should the currency exchange rate move in its favor.

  1. Currency forward contract can be used in speculating.

One can take a long position in a currency forward contract if they think that the base currency will appreciate against the price currency, and vice versa.

  1. Currency forward contract can be used in arbitrage.

Arbitrage is an act to earn profits by exploiting the mispricing in different markets. Arbitrageurs can buy currency forward contracts and short its underlying currency exchange rate if they think the currency forward contract is undervalued.

FAQ

What is hedging?

Hedging is a form of risk management where the party eliminates the risks of huge losses at the expense of reducing some potential profits. Hedging is normally carried out by commodity producers such as crude oil companies.

What is foreign currency exposure?

Foreign currency exposure happens when a company has operations in other countries. For example, if a US-based company acquires a UK-based company and continues operating in the UK, the combined entity will have foreign currency exposure.

What is speculating?

Speculating is a form of earning profit by buying a financial instrument and hoping to sell it at a higher price in the future. Speculating also includes shorting financial instruments if one thinks the price will drop in the future. All in all, speculating is a dangerous way of trading by timing the market.

What is arbitrage?

Arbitrage is a way of earning risk-free profit by exploiting the mispricing of securities in different markets. This involves buying the instrument in one market and immediately selling it at a higher price in another market.

Wei Bin Loo
Price currency interest rate
Number of days in the forward contract
days
Annualised price currency interest rate
%
Price currency interest rate
%
Base currency interest rate
Annualised base currency interest rate
%
Base currency interest rate
%
Currency forward
Spot price
Currency forward price
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