What are outrights in the Forex market?


Many international companies regularly use forward contracts to hedge foreign exchange market exposures against adverse movements and help stabilize their foreign currency cash flows. Unlike currency futures which are traded on an exchange, forward contracts are traded in the over-the-counter foreign exchange market.

Essentially, a forward contract in the foreign exchange market involves a party and a counterparty agreeing to buy or sell a predetermined amount of one currency against another at a fixed exchange rate for delivery on a specific date in the future. . Other names for futures contracts include a currency futures contract, currency futures contract, or outright transaction.

Read on for more information on futures contracts and their use in the forex market.

Understanding Outrights

To understand the futures contracts used in forex trading, you must first understand the forex spot market. In a nutshell, forex spot market transactions are settled “on the spot”. In practice, this means that spot trades are usually settled within two business days from the current trading day.

Unlike spot trades, forward contracts are usually settled on a day other than the current spot value date. Therefore, the forward contract exchange rate also includes an interest rate calculation that depends on the difference between the prevailing interest rates on interbank deposits of each currency in the traded pair.

Unless the prevailing interest rates are the same for the two currencies, the interest rate differential generally benefits the party to a forward firm transaction that holds the currency at the higher interest rate. The party holding the currency with the lower interest rate must pay the interest rate difference over the term of the forward contract.

In most cases, a futures trader must either pay the difference between the two interest rates for a currency pair or collect this differential, depending on whether the trader is long or short on the futures. This differential is incorporated into the exchange rate of the forward contract by adding or subtracting the relevant amount of swap points which are quoted by a forward exchange office.

Interestingly, if you are funding a long GBP position right now by shorting the Japanese Yen, you will receive double interest for going long GBP/JPY. Negative interest rates in Japan result in a positive carry on your short yen position as well as a positive interest rate return on the sterling you hold.

How is a forward contract different from a swap?

A forward contract is a one-legged transaction executed for a forward value date different from the current spot value date. Contrast this with a currency swap which is a two legged transaction that changes the value date of a currency position, usually to another in the future.

Regarding risk, the main difference between a forward currency position and a currency swap is that in the forward position you are exposed to both market risk and differential interest rate risk. In contrast, a currency swap only exposes you to changes in the interest rate differential.

In practice, traders can execute direct forward trades as part of their forex strategy by making a spot trade first. They then perform a currency swap to exchange the spot position on the expected delivery date. This process allows them to quickly hedge the most volatile spot market risk and then roll out the position at a more relaxed pace, as swap points tend to be more stable.

How do you calculate an outright forward?

Calculating the direct forward rate of a currency pair for a particular desired future date can be done using this formula:

Forward exchange rate or F= S[(1 + if)/ (1 + id)]

Where:

S = the spot exchange rate for the currency pair

IF = the interbank deposit rate in foreign currency or in counter-currency for the desired future date
ID= the interbank deposit rate in national or base currency for the desired future date

If the delivery date is not a full year in the future and you are shown annualized interest rates, then it will be necessary to convert those rates to partial year interest rates to use the equation above. You can do this for domestic or foreign interest rates using this calculation:

partial year interest rate = annual interest rate x (# days before settlement / # days in a year)

The calculation of swap points on a particular value date consists of taking the difference in pips between the forward firm rate F calculated above and the current spot rate S.

Exchange points = F – S

Knowing the exchange points on a certain value date means you can easily calculate the forward exchange rate for delivery on that same value date once you have received a spot exchange rate quote. Remember that if you are buying the currency pair directly as a client of a forex broker or market maker, you are trading on the supply side of the spot rate and quoted swap points.

Disadvantages of Forward Outrights

A significant disadvantage of entering into a firm futures position is that you generally cannot exchange it for cash value without performing a swap transaction. This means that your direct futures position has less liquidity than a normal spot position and you have to pay another spread to the futures office for the swap.

Another possible downside of a firm futures position is that the interest rate differential between the two currencies involved could shift, making your position less profitable. You are also fully exposed to adverse movements in the foreign exchange market when you hold a direct forward position in a currency pair.

Additionally, if you fully hedge your company’s future forex exposure using a direct forward transaction, you will forfeit any potentially beneficial movement in the forex market. This practice can reduce your company’s competitive position against others in its industry that use options, don’t hedge at all, or don’t fully hedge.

Take your FX trading to the next level with these top brokers

To successfully trade in the forex market, you will need a reliable trading partner. As a retail forex trader, you will probably want to open an account with a leading online forex broker. Benzinga has taken some of the guesswork out of selecting a suitable broker by creating the broker comparison table shown below:

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  • CedarFX is not regulated by any major financial agency. The brokerage is owned by Cedar LLC and is based in St. Vincent and the Grenadines.


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