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I am a business person operating in France and I need $100k in three months for an international payment.

If the current exchange rate is in my favor, why do I need to enter into a 3-month forward contract with a bank {which will allow me to lock it in for my future transaction}, instead of using the current exchange rate by converting euros to US dollars, then hold them for three months ?

Is using a forward contract will be cheaper for me than the rate I will receive from a bank when I exchange currency at the current exchange rate ?

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    The future exchange rate could be more in your favor, or less -- and nobody knows. Jan 13, 2018 at 22:37

2 Answers 2

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You don't need to, either way you end up with a similar rate, but there is one significant downside which is that money is locked up in dollars for the three months. Many companies use forwards to lock in rates because they would rather be more liquid keeping as much money as they can in their home currency (sometimes other currencies) in case of an emergency or a change in goals. It's generally cheaper to "undo" some forward contracts than exchange the currency back to the original. If this is not a concern for your corporation then no worries.

The forward rate and the current rate from the bank will be almost exactly the same. There will be some small differences between the two depending on the current forward rate (which for EUR/USD is usually very close to the current exchange rate) and always watch to see if there are any fees associated with the two methods.

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If you put the money in USD for three months, any return you get on the money will be in USD. But apparently you don't have a lot of need for USD. You'd probably end up just exchanging it back into EUR. Thus the utility of you holding a USD balance may be less than it is for the other party.

With the futures contract, you would have exactly the amount of USD that you want. Any interest that you earn on your money after making the agreement and before providing the amount in EUR would be in EUR.

You also may be able to do better if you provide the EUR now and get the USD in three months. If you are providing the EUR later, you can't really do anything with it during the three months. You need it at the end. But if you provide the EUR now, the recipient can use the EUR immediately and only has to worry about the USD later.

If you can't get a better price that way, then you can always hold the EUR longer. There's no one right answer. There are however patterns that are usually followed. For example, the sooner you provide the EUR, the less you have to provide. Usually. That may or may not be better than holding the money and putting it in a short term EUR investment. You'd have to compare the numbers to be sure. But if you do this a lot, you may find that there are certain patterns.

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