Forward Exchange Contract (FEC)

What Is a Forward Exchange Contract (FEC)?

A forward exchange contract (FEC) is a special type of over-the-counter (OTC) foreign currency (forex) transaction went into to exchange currencies that are not frequently traded in forex markets. These may incorporate minor currencies as well as blocked or otherwise inconvertible currencies. A FEC including such a blocked currency is known as a non-deliverable forward, or NDF.

In general, contracts](/forwardcontract) are contractual agreements between two gatherings to exchange a pair of currencies at a specific time from now on. These transactions normally happen out on the town after the date that the spot contract settles and are utilized to shield the buyer from vacillations in currency prices.

Understanding Forward Exchange Contracts (FECs)

Forward exchange contracts (FECs) are not traded on exchanges, and standard amounts of currency are not traded in these agreements. In any case, they can't be canceled besides by the mutual agreement of the two players included.

The gatherings engaged with the contract are generally interested in hedging a foreign exchange position or taking a speculative position. All FECs set out the currency pair, notional amount, settlement date, and delivery rate, and furthermore specify that the overall spot rate on the fixing date be utilized to finish up the transaction.

The contract's rate of exchange is in this manner fixed and determined for a specific date from now on, permitting the gatherings required to better budget for future financial ventures and know in advance definitively what their income or costs from the transaction will be at the predetermined future date. The idea of FECs shields the two players from surprising or adverse developments in the currencies' future spot rates.

Forward exchange rates for most currency pairs can as a rule be gotten for as long as 12 months later — or as long as 10 years for the four "major pairs."

Generally, forward exchange rates for most currency pairs can be gotten for as long as 12 months later. There are four pairs of currencies known as the "major pairs." These are the U.S. dollar and euros; the U.S. dollar and Japanese yen; the U.S. dollar and the British pound authentic; and the U.S. dollar and the Swiss franc. For these four pairs, exchange rates for a time span of as long as 10 years can be gotten.

Contract times however short as a couple of days seem to be likewise accessible from numerous suppliers. Albeit a contract can be modified, most elements won't see the full benefit of a FEC except if setting a base contract amount at $30,000.

Special Considerations

The biggest forward exchange markets are in the Chinese yuan (CNY), Indian rupee (INR), South Korean won (KRW), New Taiwan dollar (TWD), Brazilian real (BRL), and Russian ruble (RUB). The biggest OTC markets, in the mean time, occur in London, with active markets likewise in New York, Singapore, and Hong Kong. A few countries, including South Korea, have limited however restricted coastal forward markets notwithstanding an active NDF market.

The biggest segment of FEC trading is finished against the U.S. dollar (USD). There are likewise active markets utilizing the euro (EUR), the Japanese yen (JPY), and, less significantly, the British pound (GBP) and the Swiss franc (CHF).

Forward Exchange Calculation and Example

The forward exchange rate for a contract can be calculated utilizing four factors:

• S = the current spot rate of the currency pair
• r(d) = the domestic currency interest rate
• r(f) = the foreign currency interest rate
• t = season of contract in days

The formula for the forward exchange rate would be:

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

For instance, accept that the U.S. dollar (USD) and Canadian dollar (CAD) spot rate is 1 CAD purchases $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% * (90/360))/(1 + 0.25% * (90/360)) = 0.80 x (1.0019/1.0006) = 0.801

The difference due to the rates over 90 days is one 100th 100th of a penny.

Features

• FECs are traded OTC with adaptable terms and conditions, commonly referring to currencies that are illiquid, blocked, or inconvertible.
• FECs are utilized as a hedge against risk as it safeguards the two players from startling or adverse developments in the currencies' future spot rates while FX trading is otherwise inaccessible.
• A forward exchange contract (FEC) is an agreement between two gatherings to effect a currency transaction, generally including a currency pair not promptly open on forex markets.