moosemeadows

As I watch the GBP continue to spiral against the CAD due to Brexit, I've been researching foreign exchange and I've come across forward contracts- securing an exchange at today's rate for a set date in the future. If the rate is better on the date you're contracted to then the Forex company pocket the difference and if it's worse they lose out. The benefit is obviously that you get the amount you expect. It's typically done for large transfers and I see The Telegraph were praising the benefits of forward contracts for those emigrating and needing to move large chunks of money.

I can't see any mention of forward contracts in forum search results...has anyone here ever gone that route?

Pulaski

Your understanding of how the contracts work is slightly off, because the bank/fx company is not in the business of speculating on FX (a few specialists might be, but not at most banks), they make their money on the exchange spread and fees.

If you do a forward contract, the bank does the exchange now, by borrowing the currency you're going to give them, then places the proceeds on deposit until the contract matures. Then they take the funds from you to pay off the loan and give you the funds they have had on deposit. ..... That is why forward rates are based on the difference in interest rates, and why interest rates are so important in determining exchange rates. And so, despite how it appears, the bank/fx company is not "pocketing the difference".

JonboyE

I think the OP means future contracts.

Pulaski

Both exist and the way they work is identical.

JonboyE

A forward contract is exactly as you described. In a future contract the other party does not immediately buy the other currency. They are speculating. They hope the exchange rate moves in their favour between the time the contract is agreed and the date it is due. If it does they gain, if it doesn't they lose.

Pulaski

That is incorrect.

A future is traded on an exchange in a standard contract size. A forward is traded off exchange and can be of any size the parties agree.

JonboyE

I don't disagree with this. However, a in a future contract only one party gets certainty - in this case a known exchange rate at a future time. The other party is taking a punt on market fluctuations up to the time the contract is settled. To me, this is what the OP was describing.

Alan2005

Pulaski is right here.

Futures are traded on exchanges for specific dates / lot sizes.

The prices are based purely on the market for the currency on that date (usually once a quarter, or the IMM date). Both sides have margin limits and must pay/receive the difference at the end of the trading day (like what happened in trading places).

Forwards are traded based on specific periods in the future (1M, 2M). They are calculated based on the current SPOT rate with an added interest rate differential. These can be on exchanges or OTC.

They track each other very closely given that any difference is quickly arbitraged away.

What the OP actually wants is an option.

Pulaski

Nobody is "taking a punt" .... unless they want to, and exchange companies, and most banks don't want to, as I explained earlier.

Honestly, from the OP's perspective, it doesn't matter either way, makes no difference at all, but he, like you, is/was labouring under the mistaken belief that the exchange company/ bank is taking the risk; that is very rarely the case. Whether you accept that or want to believe your own version of reality is up to you.

Here's a starting point, which says, as I already said above, the two differences are that a future is a standard contract traded on an exchange and a forward contract has variable size/ terms traded "over the counter", meaning privately between two parties and not on an exchange.

Alan2005

To be pedantic. The bank might not be taking any FX risk, but it does take credit risk as it's effectively lending you money for the duration of the forward.

Usually the reason for taking forwards is to limit exchange risk, so in a sense trading a forward is taking a punt - the OP would be betting that the exchange rate is going to get worse so they are locking in the rate now.

Pulaski

They're not lending you, or anyone else, anything. There is a sum on deposit somewhere, which I suppose you could argue is a "loan", but that is with another bank, and within an approved limit, so the risk of the bank going bust is extremely small, at least within the period of the contract, which is only usually a few months, or maybe 1-2 years maximum.

There is a risk that you don't deliver the funds you were supposed to, and so they're exposed to a percentage of the contract, but that is why you have to put up a "margin" for an exchange-traded future, and usually have to put uo some sort of collateral, or be approved for a credit line sufficient to cover any market movements against you, for a forward.

Failure to provide collateral, or additional collateral if the market moves against you, causes a default and whether a future or a forward, the contract will be liquidated.

Alan2005

Which is why I said effectively. They have bought something on your behalf and you haven't paid yet - i.e. there is credit risk.

Seriously, I know how these things work.

Pulaski

And if you don't "deliver", or pay your margin call, they sell the currency they bought for you and so the exposure is confined to the movement in the exchange rate, which is only a small percentage of the contracted amount. No, you don't, or you're doing an extraordinarily bad job at explaining it!

Tirytory

It's all as clear as err ..... Mud

Alan2005

And, that's what what I said. Credit risk, i.e. the risk of not paying, the risk of default. You just described what the banks exposure is - you don't get to say there's no risk and here's what the risk is.

Well, I guess agreeing with you in general does put me at risk of not knowing what I'm talking about