This guide is provided by Alt21 Limited, trading as Alt21, an FCA authorised payments and FX provider and is intended for UK businesses considering FX hedging as part of their treasury activity. All examples provided are illustrative only and not a current or guaranteed rate. Please read the full disclaimer at the bottom of the page.
If you’re trading internationally, exchange rates rarely stay still for long.
A forward contract is a commonly used tool for businesses that want to know, in advance, what a future international payment or receipt will cost.
Rather than waiting to see where the market lands, a forward contract lets a business agree today’s exchange rate for a transaction that will happen later.
We wanted to go beyond the theory, so we sat down with two people who help businesses navigate this every day, Tom Vooght, Head of Sales at Alt21, and Chris Canning, Vice President of Sales and Trading at Alt21.
As Alt21 employees, their comments throughout this guide reflect their own experience working with Alt21’s clients and describe Alt21’s own products and approach, rather than independent market commentary. Their insight into how businesses actually use forward contracts to manage currency exposure runs throughout this guide.
Here, you’ll also discover how a currency forward contract works, with a practical example and a clear look at the benefits and limitations finance teams should weigh up.
By the end, you’ll have a clearer picture of whether a forward currency contract is worth considering as part of your business’s financial planning.
Quick summary
- An FX forward contract is an agreement between two parties to exchange one currency for another at a fixed, pre-determined rate on a set future date.
- The difference between futures and forwards is that a forward is a custom deal between two private parties to trade an asset later at a set price while a future is a standardised, exchange-traded agreement to buy or sell an asset at a future date.
- As with any financial product, a forward contract has pros and cons. What suits one business may not suit another, and suitability depends on individual circumstances, trading patterns and objectives.
- The forward contract exchange rate is calculated using the spot rate together with the interest rate differential between the two currencies involved, over the length of the contract.
What is a forward contract?
A forward contract is an agreement between two parties to exchange one currency for another at a set rate, on a specific date in the future. It’s a type of forward exchange contract, meaning the exchange rate is fixed at the point the agreement is made, rather than on the day the money actually changes hands.
Unlike spot transactions, which settle almost immediately at the current market rate, a forward FX contract settles later, often weeks, months, or occasionally longer down the line. The rate agreed on day one is the rate that applies on the settlement date, regardless of how the market has moved in between.
As Tom puts it:
“Say you’re a UK distributor buying supplies from a supplier in China. You’ve agreed the shipment will cost you $3 million, but you don’t need to pay until it arrives in 90 days. A forward contract lets you agree today’s exchange rate for that payment now, rather than finding out what it’ll cost you in three months’ time.”
Businesses typically use a foreign currency forward contract when they know they’ll need to make or receive a payment in another currency at some point ahead, but want to remove the guesswork around what that payment will actually cost. This is particularly common among:
- Importers who pay overseas suppliers in a foreign currency
- Exporters who invoice international customers and receive payment later
- Manufacturers with regular international supply chains
- Businesses that quote fixed prices to overseas customers months in advance
It’s worth being clear about what a forward contract is not:
It isn’t a way to speculate on currency movements, and it isn’t a guarantee that a business will get a “better” rate than the market. It’s simply a way to agree a rate in advance, so that future costs can be planned with more clarity, whatever direction the market moves in afterwards.
Chris put it simply:
“If you get an invoice landed on your desk today, and it’s priced in dollars, you buy the dollars, and you know the cost. If the invoice needs to be paid next month, you’ve no idea today what the cost is going to be next month. So at that stage, for that period of time, you are at risk – the rates may move up, down, it might cost you more, cost you less. What a forward contract does is allow you to agree a rate of exchange today for a future date. So you know exactly what you’re going to be paying next month.”
A cross currency forward contract works on the same principle, even where neither currency involved is the business’s home currency. For example, a UK business agreeing a future exchange rate between US dollars and euros to settle an overseas contract.
Because the rate is fixed at the outset, a forward contract can support more informed budgeting and forecasting. Whether that’s helpful for a particular business depends on its own trading patterns, payment timing, and appetite for agreeing a rate ahead of time. It isn’t a solution that suits every business or every transaction.
Businesses typically arrange a forward currency contract through a bank, a specialist FX broker, or a currency management platform.
The process generally follows a few clear steps:
- The business agrees the currency pair, amount and settlement date with its provider.
- The two parties confirm the rate that will apply.
- The rate is fixed regardless of how the underlying market behaves between now and settlement.
It’s also worth noting that a forward contract doesn’t need to cover an entire payment in one go.
Some businesses choose to split a larger exposure across several forward contracts with different settlement dates, which can make sense where payments are staggered over several months rather than due all at once.
This kind of approach often sits alongside other tools, such as target rate orders or FX options, as part of a wider strategy for managing currency exposure across the year.
You might be interested in reading our guide to dynamic hedging.
What’s the difference between futures and forwards?
The forward contract vs future contract question comes up often, because the two products are built on the same basic idea:
Agreeing a price today for a transaction that happens later.
But they work quite differently in practice:
| Forward contract | Futures contract | |
| Where it’s traded | Over-the-counter (OTC), agreed directly between two parties | On a regulated exchange |
| Terms | Customisable — amount, currency pair and date can be tailored | Standardised contract sizes and settlement dates |
| Settlement | Typically settled once, on the agreed date | Marked to market and settled daily |
| Counterparty | The business and its provider (such as a bank or FX platform) | The exchange itself, via a clearing house |
| Flexibility | Can be adapted to match a business’s exact payment or receipt | Limited to available contract specifications |
The forwards vs futures distinction matters most when it comes to flexibility.
A forward currency exchange contract can be shaped around a specific business need, such as an unusual settlement date or an amount that doesn’t fit a standard contract size.
As Chris explains, the mechanics stay the same, however it’s structured:
“Regardless of what type of forward we’re buying – a fixed forward, a flexible forward, an open-dated forward – we’re doing the same as a spot deal. We’re buying a fixed amount of currency for a fixed value date. The only difference is that the value date is in the future rather than today.”
Futures, on the other hand, are designed for exchange trading, which means they come with fixed contract sizes, standard expiry dates, and daily settlement of gains and losses.
For many growing businesses managing supplier payments or customer receipts, a forward contract can be a practical option because it can be tailored to the actual transaction rather than a standardised structure.
Futures are more commonly used by larger institutions and traders who need exchange-traded instruments for other reasons, such as accounting treatment or liquidity requirements.
Tom sees this play out with clients coming from a banking relationship:
“A lot of people come to us from a bank relationship, and banks can be more rigid about how forwards are structured. We’re often able to offer more flexibility – for example, rolling a contract, or using it early if things change.”
Another difference between futures and forwards is counterparty risk.
Because a forward is agreed directly between two parties, its performance depends on both sides meeting their obligations.
Chris explains what that looks like on Alt21’s side specifically:
“We’re a matched principal broker. When you book a forward contract with us, we take out the same forward contract with our counterparty – with a small difference in rate, which is our spread. We’re not trying to play or speculate on the market ourselves; we settle with our counterparty exactly as you settle with us.”
Futures contracts, cleared through an exchange, remove much of that direct counterparty exposure, though this comes at the cost of the standardisation mentioned above.
There’s also a practical difference in how each product is typically used.
Futures contracts are often associated with traders and financial institutions that need a liquid, exchange-traded instrument, sometimes for reasons unconnected to an underlying commercial payment. For example, taking a position on currency movements rather than settling an actual invoice.
A forward currency contract, by contrast, is generally used by businesses with a genuine commercial need – A supplier to pay, an invoice to be settled, or a customer receipt expected on a known date.
This difference in purpose is often just as important as the structural differences set out above when deciding which route makes sense for a particular business.
You may be interested in reading our guide on FX risk management.
Example of a forward contract
Here’s a simple currency forward contract example to illustrate how this works in practice.
Imagine a UK-based manufacturer that has agreed to buy components from a supplier in the United States. The invoice, worth $500,000, is due for payment in three months. The current spot exchange rate is 1.25 USD to 1 GBP, meaning the invoice would cost roughly £400,000 today.
The finance team is concerned that the pound could weaken against the dollar over the next three months, increasing the cost of the payment in sterling terms.
Suppose the agreed forward rate is 1.24 USD to 1 GBP (forward rates typically differ slightly from the spot rate, reflecting the interest rate differential between the two currencies – more on that below).
When the three months pass:
- If the pound has weakened to 1.15 USD to 1 GBP, the business still pays based on the agreed rate of 1.24, which means the payment costs less in sterling than it would have done at the new market rate.
- If the pound has strengthened to 1.30 USD to 1 GBP, the business still pays based on the agreed rate of 1.24, which means the payment costs more in sterling than it would have done at the new market rate.
Either way, the business already knew, three months in advance, exactly how many pounds the payment would require.
That’s the core purpose of a forward contract – replacing uncertainty about a future cost with a known figure that can be built into budgets and forecasts from the outset.
The same principle works in reverse for a business receiving money in a foreign currency.
Take an Irish software company that has agreed a €200,000 contract with a customer in the eurozone, with payment due in six months, but which reports its results in sterling.
Rather than waiting six months to find out how many pounds that €200,000 will convert to, the finance team can agree a forward contract now, fixing the sterling value of that future receipt. This can make it considerably easier to forecast revenue in the company’s reporting currency, regardless of what happens to the euro-sterling rate between now and settlement.
Here’s how Tom describes a typical case that plays out with clients:
“A client has relatively fixed spot transactions – say they do roughly £100k every month buying euros to pay salaries in Europe. If they’ve never used anything beyond spot before, we’d explain that a forward contract lets you agree a rate over a specific timeframe, where you can draw down from that contract in whatever size increments you like, whenever you like. And if you get to the end of the contract and haven’t used it all, you can roll it on to a later date. That means the business can put a fixed number into its own spreadsheets – this is what it’s going to cost us each month – rather than scrabbling around wondering if the rate’s about to move against them. The trade-off is that if the rate moves in their favour instead, they’re still paying the agreed rate.”
Forward contract pros and cons
As with any financial product, a forward contract has trade-offs. What suits one business may not suit another, and suitability depends on individual circumstances, trading patterns and objectives.
Tom sees this pattern often:
“I think why people like it is because it reduces any surprises. The people we’re speaking to, CFOs, FDs, are generally quite risk-averse, so knowing the cost in advance, rather than finding out later, is what they’re looking for.”
No upfront premium is payable to open a standard forward contract, although margin may still be required in some cases, as set out below.
Potential benefits
- Cost planning: Knowing the exact sterling cost of a future payment or receipt can support more accurate budgeting and forecasting.
- More predictable pricing decisions: Businesses quoting customers in a foreign currency can price with a known exchange rate in mind, rather than trying to build in a margin for market movement.
- Flexibility of terms: As an OTC product, a forward FX contract can usually be tailored to match the exact amount, currency pair and date required.
- No upfront premium: Unlike some other hedging tools, a standard forward contract typically doesn’t require an upfront cost to enter into.
Potential limitations
- No participation in favourable moves: Because the rate is fixed, a business won’t benefit if the market moves in its favour before settlement.
- Commitment to settle: A forward contract is typically an obligation, not a choice — unlike an FX option, which gives more flexibility around whether to proceed.
- Less useful for uncertain timing: If a business isn’t sure exactly when a payment will be made, a fixed forward contract may be harder to match to the actual transaction date.
- Requires a reasonably firm view of future cash flow: Forward contracts work best when a business has good visibility of upcoming FX international payments or receipts.
- May require margin: Depending on the provider, contract size and duration, a forward contract may require margin to be posted or topped up if the market moves significantly before settlement.
For businesses whose payment dates or amounts are less predictable, a flexible forward contract, which allows drawdown across a window of dates rather than a single fixed date, or an FX option may be worth exploring instead. The right approach depends on how a business’s international payments behave.
It’s also worth thinking about a forward contract alongside a business’s wider financial planning cycle, rather than in isolation.
A single forward contract can help with a specific payment or receipt; businesses with regular, ongoing currency exposure may find it worth reviewing forward contracts as part of a broader approach to managing currency risk.
Considering questions such as how much of their exposure to cover, over what time horizon, and how that fits with cash flow and reporting requirements are exactly the kind of questions a structured hedging strategy is designed to help answer.
What is the price of a forward contract?
The forward contract exchange rate isn’t simply the current spot rate carried forward unchanged. It’s calculated using the spot rate together with the interest rate differential between the two currencies involved, over the length of the contract.
This relationship is known as covered interest rate parity, and it exists to prevent risk-free arbitrage between the spot and forward markets.
In practical terms, it means:
- If the currency you’re buying has a higher interest rate than the currency you’re selling, the forward rate will typically be less favourable than the spot rate (this is known as being at a “discount”).
- If the currency you’re buying has a lower interest rate than the currency you’re selling, the forward rate will typically be more favourable than the spot rate (a “premium”).
This is why, in the earlier currency forward contract example, the forward rate of 1.24 differed from the spot rate of 1.25. The difference reflects the interest rate gap between the US dollar and sterling over those three months, rather than any prediction about where the market is headed.
It’s a common misconception that a forward rate is the market’s forecast of future spot rates. In reality, forward contract rates are a mathematical function of today’s spot rate and interest rates, not a prediction of where a currency pair is headed.
This is one of the more counterintuitive aspects of how a forward FX contract works, and it’s worth restating clearly:
The forward rate isn’t anyone’s guess about the future. It’s derived, using established interest rate parity calculations, from information that’s already known today. The current spot rate and the prevailing interest rates in each currency.
The further out the settlement date, and the wider the gap between the two countries’ interest rates, the more the forward rate will typically diverge from today’s spot rate.
For shorter-dated contracts, or currency pairs with similar interest rates, that difference tends to be relatively modest.
Learn more about calculating forward points in our guide.
How to value a forward contract?
Once a forward contract has been agreed, its value can move over the life of the contract, even though the rate itself is fixed.
This matters for businesses that need to report the value of open forward contracts for accounting purposes, or that want to understand their current position before settlement.
The value of a currency forward contract at any point before settlement is essentially the difference between:
- The rate originally agreed in the contract, and
- The rate at which a new, equivalent forward contract could be agreed today, for the same remaining settlement date
That difference is then discounted back to today’s value, since the actual gain or loss won’t be realised until the settlement date arrives.
In simple terms:
- If current forward rates have moved in the business’s favour compared to the rate it originally locked in, the contract will typically show a positive value.
- If current forward rates have moved against the business compared to its original rate, the contract will typically show a negative value.
This is why forward contracts are often described as “marked to market” for reporting purposes, even though, unlike futures, no cash actually changes hands until the agreed settlement date.
Businesses with a portfolio of forward contracts, particularly those using structured hedging as part of a wider currency strategy, often review this valuation regularly as part of their financial planning and reporting cycle.
A currency forward contract feeds into wider decisions, such as whether existing contracts still align with the business’s current cash flow expectations, or whether it’s worth discussing adjustments with a provider if underlying trading patterns have changed since the contract was first agreed.
This is generally a conversation to have directly with your FX provider, since the specific approach to valuation, reporting and any adjustments can vary depending on the terms of the original agreement. 
(Applicants must pass Alt21’s onboarding process and accept our terms and conditions before becoming a client.)
FAQs
What’s the difference between a forward exchange contract and a spot transaction?
A spot transaction settles at the current market rate, almost immediately. A forward exchange contract settles later, at a rate agreed today rather than on the settlement date.
Are forward contracts only for large businesses?
Growing businesses with regular international payments, or predictable future currency exposure, can also use forward contracts as part of their financial planning.
Can I cancel a forward contract once it’s agreed?
This depends on the terms agreed with your provider. Some forward contracts can be closed out or adjusted before the settlement date, though this may involve additional considerations depending on how the market has moved.
Do forward contracts require a deposit?
This varies by provider and by the size and length of the contract. Some providers may require margin to be posted upfront or topped up if the market moves significantly before settlement. It’s worth confirming the specific terms with your FX provider before agreeing.
How far in advance can a forward contract be arranged?
This depends on the provider and the currency pair involved, but forward contracts are commonly arranged for periods ranging from a few weeks to a year or more ahead.
Is a forward contract the same as hedging?
A forward contract is one of several tools businesses can use as part of a wider approach to managing currency exposure. Other tools, such as FX options and structured hedging, can be used alongside or instead of forward contracts, depending on a business’s circumstances and objectives.
ALT21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by ALT21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. ALT21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by ALT21 Limited. Not all applications will be accepted.
