Forward contract

A forward is the instrument a corporate treasury reaches for first. It is agreed directly with a bank rather than bought on an exchange, so the amount, the currency pair and the settlement date are negotiated to match the underlying exposure exactly. If the invoice falls due in March, the forward settles in March, for the invoice amount.

No cash changes hands until settlement and there is no fee line. The bank's margin is embedded in the rate quoted, which is one reason a company with several relationship banks will put a large hedge out to more than one of them.

The feature candidates miss is credit. A forward is an exposure running both ways, because whenever the contract moves in the company's favour the bank is owed nothing and the company is owed something. Banks therefore charge the hedge against a credit line, and that line is the same resource the revolving facility draws on. A company approaching its limits can discover it cannot put on the hedge at precisely the moment the exposure has become frightening.

One further point, because it is a reliable trap. A forward rate is spot adjusted for the interest rate differential between the two currencies, which is covered interest parity. It is not the market's forecast of where spot will be. A candidate who reads a forward curve as a prediction is making a confident sounding error, and the same applies to a commodity forward curve, whose shape reflects storage and financing costs rather than a consensus view.

And a forward binds in both directions. The company pays the agreed rate whether the market ends up above or below it. Giving up the favourable move is the price of certainty, and an instrument that protects only against the adverse move is an option, paid for with a premium.