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
- 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))
Value of a Currency Forward with Continuous Compounding
Vt(0,T)X/Y = (St,X/Y e-ry(T-t)) - (F(0,T)X/Y e-rx(T-t))
- CFA Level 2: Derivatives Part 1 – Introduction
- What are Forward Contracts?
- Equity Forward Contracts
- Fixed Income Forward Contracts
- Currency Forward Contracts
- Forward Rate Agreements (FRA)
- Credit Risk and Forward Contracts
- Introduction to Futures Contracts
- Futures: Convergence of Spot and Futures Prices at Expiration
- Futures Prices vs. Forward Prices
- Contago and Backwardation
- Pricing Stock Index Futures
- Pricing Interest Rate/Treasury Bond Futures
- Pricing Currency Futures
- Eurodollar Futures
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