What it means
A forward contract is an agreement between two parties to exchange an asset or currency at a fixed price on a future date. Unlike futures, forwards are customised and traded privately, usually with a bank.
A long date forward simply stretches the settlement beyond the usual one-year horizon, sometimes to five years or more. Businesses use these contracts to protect long-term projects.
An airline buying aircraft in euros over three years, or an exporter with a multi-year supply deal in a foreign currency, can fix the rate for future payments. This removes the uncertainty from the budget and protects the project's margin.
The forward rate is not a prediction of where the spot rate will be. It is based on the current spot rate and the interest rate difference between the two currencies, which is why it can be calculated from market data.
The currency with the higher interest rate trades at a forward discount, and the one with the lower rate trades at a forward premium. Long date forwards carry extra risks.
The bank takes credit risk for many years, so it may require collateral or a credit line, and the company may need to post margin if the market moves. If the company's plans change, closing the contract early may produce a gain or loss based on market rates at that time.
Accounting rules often require forward contracts to be shown at fair value. If the contract is designated as a hedge of a future transaction, special hedge accounting rules can reduce volatility in reported profit.
Finance teams should agree the treatment with their auditors before entering the contract.
In practice
Real-world examples.
Example
A manufacturer signs a three-year contract to buy machinery for 8,000,000 euros, payable in instalments. It enters a series of long date forwards to fix the dollar cost of each payment. The finance director can now set a firm budget.
Example
An exporter expects to receive payments from a customer in a foreign currency for the next four years. She sells the currency forward for each date to protect her margin. If the currency weakens, the gain on the forward offsets the lower sales value.
Example
An infrastructure fund has a long-term investment in a foreign project that will pay dividends in five years. It sells the expected dividend forward to fix the amount in its home currency. The bank asks for a credit line to support the long contract.
Formula
Calculation
Forward rate = Spot rate x [(1 + Interest rate in the quote currency) / (1 + Interest rate in the base currency)]^Years
Assume the spot rate is $1.10 per euro, the dollar interest rate is 4% and the euro interest rate is 2%. The two-year forward rate is $1.10 x (1.04 / 1.02)^2. The ratio 1.04 / 1.02 is about 1.0196, and squaring it gives about 1.0396. The forward rate is $1.10 x 1.0396 = about $1.1436 per euro. For a payment of 5,000,000 euros, the locked-in cost is 5,000,000 x $1.1436 = $5,718,000, compared with $5,500,000 at today's spot rate.Case study
Seen in the real world.
Calloway Aerospace is an illustrative, fictional company that won a four-year contract to supply parts, with revenue in euros and costs in dollars. The finance team feared that a stronger dollar would cut its margin from 12% to almost nothing.
The treasurer arranged long date forwards covering 70% of the expected euro receipts over the four years. She chose the percentage to keep some flexibility in case the contract volume changed, and she agreed credit terms with the bank.
In year two, the dollar strengthened by 9% against the euro. The forwards locked in more favourable rates for most of the revenue, and the margin stayed close to plan. The story is illustrative, but it shows that hedging a long project reduces uncertainty, although the company gives up the chance to benefit if the market moves its way.
Watch out
Common mistakes.
- Hedging the full expected amount when the underlying volume is uncertain, which can leave the company over-hedged.
- Assuming the forward rate predicts the future spot rate, when it reflects interest rate differences.
- Forgetting that the bank takes credit risk and may require collateral or limits.
Questions
People also ask.
Why is the forward rate different from today's spot rate?
It reflects the interest rate difference between the two currencies, so one currency trades at a premium and the other at a discount.
Can I close a long date forward early?
Usually yes, by agreeing a settlement with the bank, and the result depends on market rates at that time.
How long is a long date forward?
Typically it means longer than one year, and some banks quote contracts for five years or more.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%