A currency forward is a binding contract in the foreign exchange market that locks in the exchange rate for the purchase or sale of a currency on a future date. Unlike futures, forwards are customized over-the-counter (OTC) agreements between two parties, commonly used by businesses to hedge against exchange rate fluctuations. The forward rate is determined by the spot rate adjusted for the interest rate differential between the two currencies.
Example
“A European importer expecting to pay $1 million to a US supplier in three months enters a currency forward contract locking in an exchange rate of 1.10 EUR/USD, eliminating the risk of the dollar strengthening before payment is due.”