What is an FX forward, and who actually needs one?
A forward outright is the same contract as spot with one field changed: the value date is further away. You agree today to exchange two currency amounts on a date weeks or months from now, at a rate fixed today. No money moves at inception.
It exists because businesses know their future currency needs long before those needs arrive, and a rate that moves 10% in six months turns a profitable contract into a loss.
The canonical user
A German manufacturer signs a contract to be paid USD 5,000,000 in three months. Its costs are in euros. It has, without wanting one, a three-month bet on EUR/USD.
It sells the dollars forward. The rate is agreed now; the exchange happens on the value date in three months; and the euro amount it will receive is known today, so it can be put in a budget. It has not made money and it has not predicted anything. It has removed a variable.
Where the price comes from — not a forecast
The single most common misreading in FX is that the forward rate is the market's expectation of the future spot rate. It is not. It is arithmetic on two interest rates:
F = S × (1 + r_quote × t) ÷ (1 + r_base × t)
where t is the tenor as a fraction of a year on the relevant day-count (most currencies use ACT/360; sterling and a few others use ACT/365).
Worked, with EUR/USD spot 1.0800, three months (90 days), USD at 4.50%, EUR at 2.50%:
- Numerator: 1 + 0.0450 × 0.25 = 1.01125
- Denominator: 1 + 0.0250 × 0.25 = 1.00625
- F = 1.0800 × 1.01125 ÷ 1.00625 = 1.08537
The three-month forward sits about 54 pips above spot. That is not a view that the euro will rise. It is the only rate that prevents a risk-free profit: if the forward were anywhere else, you could borrow one currency, convert, lend the other, and lock in money for nothing. The principle is covered interest parity, and the next lesson proves it with a second route to the same number.
The rule that falls out of it
Because the quote currency's rate is on top, the higher-yielding currency always trades at a forward discount. Dollars pay 4.50% and euros 2.50%, so dollars buy fewer euros forward than they do today.
This has a consequence worth carrying into the next course: any strategy of holding a high-yielding currency is, in the forward market, priced to break even. The forward market charges you exactly the interest advantage. Whether spot actually moves that way is a different question entirely — one the arithmetic does not answer.
Why a forward is a bank product
A forward is an unsecured promise running for months. Its value drifts away from zero as spot moves, so it consumes a credit line, or requires collateral under a formal agreement. Banks extend that credit to clients whose business they know. This is why real forwards are corporate and institutional instruments, and why the retail equivalent — Unit 3 — is a different contract wearing similar clothes.
Variations exist for practical reasons: a window forward lets a company draw down between two dates when the exact payment day is uncertain, and a par forward blends a series of dates into one rate.
Try it now
- Today's euro-dollar spot is below, and under it the latest overnight reference rate for each of the two currencies: SOFR for the dollar, €STR for the euro. Both are overnight fixings, so treat them as stand-ins for the 3-month rates the formula wants and say so beside your answer.
- Compute the 3-month forward with the formula above. Confirm which currency is at a forward premium and check that it is the lower-yielding one.
- Restate the result in one sentence without the word "expect". If the sentence still sounds like a prediction, rewrite it — a forward rate is arithmetic, not an opinion.