Skip to main content Skip to accessibility page Skip to search input

Forward transaction

Forward Exchange Contracts

A Forward Exchange Contract is a contract between St.George Bank Ltd and you where the Bank agrees to BUY from you, or SELL to you, foreign currency on a fixed future date, at a fixed rate of exchange. You undertake to pay the Bank, the overseas currency in terms of the contract in exchange for the settlement currency, which would usually be Australian Dollars.

The Bank can provide a Forward Exchange Contract in most overseas currencies, for the protection of Exporters and Importers who are subject to exchange risks in the course of their international transactions.

What are Forward Exchange Contracts?

A Forward Exchange Contract is an agreement between you and the Bank, in which the Bank agrees to Buy or Sell foreign currency to you on a fixed future date, or during a period expiring on a fixed future date, at a fixed rate of exchange. You undertake to pay the Bank, or receive from the Bank, the overseas currency in terms of the contract in exchange for the settlement currency, usually Australian Dollars.

The Bank can provide a Forward Exchange Contract in most overseas currencies, for the protection of Exporters and Importers who are subject to exchange risks in the course of their international transactions.

Forward Exchange Contracts can be used to cover your exchange risk between an overseas currency and Australian dollars or between two overseas currencies. The contract may be entered into at anytime and can be used to cover both trade and non-trade transactions.

As with the Exchange Rate, Forward Exchange Contracts are described as Buying or Selling Contracts. For an Importer, the Bank contracts to sell overseas currency, hence a Bank Selling Contract is established for a future date. At maturity, the Bank Selling Contract is used to meet the Importer's overseas commitment. In the case of an Exporter the contract is a Buying Contract.

An Australian Importer may place an order overseas for goods with payment to be made to the supplier in overseas currency. The Importer knows the Selling Exchange rate for the currency concerned when he places an order, and can calculate the costs of the goods in Australian currency at that time.

However, a payment to the overseas supplier is seldom made at the time of placing the order. The Exchange Rate may alter before the Importer is due to make payment or the actual cost of the goods may vary significantly. Therefore the Importer has an exchange risk.

The establishment of a Forward Exchange Contract will enable the Importer to protect against adverse movements in the exchange rate, but cannot provide a 'perfect' hedge should the actual cost of the goods vary.

Types of Forward Exchange Contracts

Forward Exchange Contracts, both Buying and Selling, may be either fixed or optional term contracts.

Fixed Term Contracts

With a Fixed Term Contract the customer specifies the date on which delivery of the overseas currency is to take place. An earlier delivery can be arranged but it may involve a marginal adjustment to the Forward Contract Rate.

Optional Term Contracts

Optional Term Contracts can be entered into for a specific period, and the customer states the period within which delivery is to be made (normally for periods not more than one month), e.g. a contract may be entered into for a six month period with the customer having the option of delivery at anytime during the last week.

In each case there is a firm contract to effect delivery by both the Bank and the customer. An optional delivery contract does not give the customer an option to not deliver the Forward Exchange Contract. It is only the period during which delivery may occur that is optional.

Forward rates are quoted for transactions where settlement is to take place more than two business days after the transaction date. Forward Contract rates consist of the Spot rate for the currency concerned adjusted by the relative Forward Margin.

Forward Margins are a reflection of the interest rate differentials between currencies, and not necessarily a forecast of what the spot rate will be at the future date. Therefore it is essential for the Financial Controller to be aware of the interest rates prevailing in the countries with which their Company is doing business.

The Forward rate may be expressed as being at parity (par), or at a Premium (dearer) or at a Discount (cheaper), when related to the spot rate. It follows therefore that premiums are deducted from the spot rate and discounts are added to the spot rate.

Forward Rates incorporating a 'Premium' are more favourable to exporters and less favourable to importers than the relative spot rates on which they are based. Similarly, Forward rates incorporating a 'Discount' are more favourable to importers and less favourable to exporters that the relative spot rates on which they are based.

The general rule in determining whether a currency will be quoted at a premium or a discount is as follows:

  • The currency with the higher interest rate will be at a discount on a forward basis against the currency with the lower interest rate.
  • The currency with the lower interest rate will be at a premium on a forward basis against the currency with the high interest rate.

As the interest differential between the currencies widens then the premium or discount margin increases (i.e. moves farther from parity) and similarly as the interest differential narrows then the premium or discount margin decreases (i.e. moves towards parity).

Importers

The importer buys the foreign currency at spot (i.e. forgoes use of AUD) and invests the foreign currency until required. On due date of the payment, the foreign currency deposit matures, plus interest earned, and the payment to the overseas supplier is made.

Consideration must be given to the taxation and cash flow implications of hedging your exchange risk in this manner.

Exporters

The exporter could borrow the foreign currency (representing proceeds to be received at a future date), and sell the borrowed foreign currency to the Bank at spot, for which AUD is received. The proceeds from the export sale are later used to repay foreign currency borrowing.

Example

Australian Importer has a commitment to pay USD for goods in six months time.

Exchange Risk
AUD/USD

Calculation of Forward Rate
Spot Selling Rate .5100
Less Margin - .0033
Forward Rate .5067

Interest Rate
Calculation of Margin
Borrow AUD at cost of 6%
Place USD on Deposit at 3.0%
Deposit matures, net interest cost –3.0%
*Interest Difference is expressed as a number (e.g. –1.3% = .0033) for the period of the contract.
In effect, the forward rate represents the 'price' of covering a forward exchange risk.

The 'cost' of covering an exchange risk is not simply the discount or premium by which the spot rate is adjusted at the time the forward contract is entered into, but rather it is the difference between the contract rate and the spot rate at the time delivery is affected. In other words if the decision had been taken not to cover forward then the transaction would have been handled at the future spot rate.

Need more information?

If you have any questions or want more information, you can contact us online or call us toll free on 1300 665 616.

Read the Product Disclosure Statement.