- 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:
- S
_{0}= Spot exchange rate for X/Y (#X units domestic per 1Y foreign) at initiation - r
_{X}= Risk free rate in country X (domestic currency) - r
_{Y}= Risk free rate in country Y (foreign currency) - Price of a Currency Forward with Continuous Compounding
- Value of a Currency Forward with Simple Compounding
- Value of a Currency Forward with Continuous Compounding

F(0,T)

_{X/Y}= S_{0,X/Y}× ((1+r_{X})/(1+r_{Y}))^{T}Where:

F(0,T)

_{X/Y}= (S_{0,X/Y}e^{-r}y^{T}) e^{r}x^{T}
V

_{t}(0,T)_{X/Y}= (S_{t,X/Y}/ (1+r_{Y})^{(T-t)}) – (F(0,T)_{X/Y}/ (1+r_{X})^{(T-t)})
V

_{t}(0,T)_{X/Y}= (S_{t,X/Y}e^{-r}y^{(T-t)}) – (F(0,T)_{X/Y}e^{-r}x^{(T-t)})
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