# Currency Forward Contracts

• A currency forward contract involves two currencies and two interest rates. A currency forward contract lets you lock-in a pre-defined price at which you can buy/sell a currency on a future date.
• Contract parties commonly enter into currency forwards with the objective of hedging exchange rate risk exposure.
• The interest rates can be interpreted as a net cash flow yield of investing one currency in a risk free asset and borrowing the other currency.

### Price of a Currency Forward with Simple Compounding:

F(0,T)X/Y = S0,X/Y × ((1+rX)/(1+rY))T

Where:

• S0 = Spot exchange rate for X/Y (#X units domestic per 1Y foreign) at initiation
• rX = Risk free rate in country X (domestic currency)
• rY = Risk free rate in country Y (foreign currency)

### Price of a Currency Forward with Continuous Compounding

F(0,T)X/Y = (S0,X/Y e-ryT ) erxT

### Value of a Currency Forward with Simple Compounding

Vt(0,T)X/Y = (St,X/Y / (1+rY)(T-t)) - (F(0,T)X/Y / (1+rX)(T-t))