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We are selling some custom made products which we need to buy materials for in different currencies e.g. 100 USD + 50 EUR + 20 SGD, and we sell the products in a currency that our customer prefers e.g. 350 EUR.

I am looking at ways to save money on the exchange rate and came across the term "forward selling" and it was suggested that we should "forward sell currency net of same currency purchases".

While searching online I keep finding the term forward contracts but not sure if they are the same thing. So to reinforce my understanding, in the above example, does "forward selling" means to strike a contract with the bank to sell EUR (selling currency) in exchange for 100 USD + 20 SGD?

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Why the down votes anybody? Seems like a good question about money. The background is business related, but the question itself is good. –  MrChrister Sep 12 '12 at 18:03

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up vote 2 down vote accepted

In short, yes. By "forward selling", you enter into a futures contract by which you agree to trade Euros for dollars (US or Singapore) at a set rate agreed to by both parties, at some future time. You are basically making a bet; you think that the dollar will gain on the Euro and thus you'd pay a higher rate on the spot than you've locked in with the future. The other party to the contract is betting against you; he thinks the dollar will weaken, and so the dollars he'll sell you will be worth less than the Euros he gets for them at the agreed rate.

Now, in a traditional futures contract, you are obligated to execute it, whether it ends up good or bad for you. You can, to avoid this, buy an "option". By buying the option, you pay the other party to the deal for the right to say "no, thanks". That way, if the dollar weakens and you'd rather pay spot price at time of delivery, you simply let the contract expire un-executed. The tradeoff is that options cost money up-front which is now sunk; whether you exercise the option or not, the other party gets the option price. That basically creates a "point spread"; you "win" if the dollar appreciates against the Euro enough that you still save money even after buying the option, or if the dollar depreciates against the Euro enough that again you still save money after subtracting the option price, while you "lose" if the exchange rates are close enough to what was agreed on that it cost you more to buy the option than you gained by being able to choose to use it.

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Thank you for the very complete answer! –  Jake Aug 2 '12 at 6:17

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