Range Forward Contract

What is ‘Range Forward Contract’

It is a zero-cost currency forward contract that employs a variety of exchange rates rather than a single rate and has no transaction costs. It is designed in such a way that it gives complete protection against unfavourable exchange rate movements while still preserving some upside potential in order to profit from positive currency swings. In most cases, it is utilized by businesses and international traders to hedge their currency risk at a little or no cost.

Explaining ‘Range Forward Contract’

Consider the case of a U.S. corporation that has received a EUR1 million export order from a European client as an illustration. A sudden drop in the value of the euro (which is currently trading at 1.30 to the US dollar) over the next three months – during which payment is expected – has raised concerns for the company, which has sought to hedge its exposure while retaining some upside.

With its financial institution, the corporation might arrange a three-month range forward contract with a floor of EUR1.27 and a ceiling of EUR1.33 that has a floor of EUR1.27 and a cap of EUR1.33. If the spot exchange rate is EUR1 = US$1.31 at the time of expiration, the contract settles at the spot rate (since it is within the 1.27 – 1.33 range). The corporation receives the floor rate of 1.27 if the exchange rate at expiration is EUR1 = US$1.25 at the time of expiration. In the alternative, if the exchange rate at expiration is EUR1 = US$1.36, the corporation receives a cap rate of 1.33, as shown in the table.

Range Forward Contract FAQ

What is range forward contract?

Range forward contracts are designed to provide settlement for assets that are priced within a certain range. They are required to hold two derivative market positions, each of which creates a reach for settlement at a later date. In order to trade ranger forward contracts, a broker must take both a long and a short position via the use of two different derivative agreements.

What is Range Forward OTC?

When using forward agreements, you may simulate the reward profile of purchasing a call in the money and selling a put in the money, which is useful for FX collars.

What is forward contract example?

A forward contract is a kind of derivative financial instrument. Fundamental resources for derivatives might include commodities such as gold or silver as well as foreign currencies, market data, and individual stocks, among others. The parties to a forward contract agree to acquire or sell a fundamental asset at a price that both parties agree on at a future date that has been specified.

How do forward contracts work?

The parties to a forward contract agree to acquire or sell a fundamental asset at a price that both parties agree on at a future date that has been specified. The forward price is the value that has been agreed upon. This agreed-upon value is derived by combining the spot price and the risk-free rate, among other things.

What are the problems of forward markets?

Forward markets are suffering from a number of challenges, including a lack of centralization of trading, a lack of liquidity, and a high level of counterparty risk. Adaptability and generality are the two most important concerns to consider in the first two issues.

How do you close a forward contract?

To bring a Forward contract to a conclusion, carry out the conveyance or take conveyance in accordance with the terms and decisions of the contract. Roll the contract forward to a future date at the current rate of exchange. Close out the contract by acquiring or selling a balancing contract at market prices that are favorable to the transaction's final outcome.

How is future contract better than forward contract?

It is possible to swap a forward agreement over-the-counter since it is a private, adjustable agreement that settles when the agreement comes to an end. When compared to a forward contract, a future contract has normalized terms and is traded on a stock market, where expenses are determined on a steady daily schedule until the contract expires.

Further Reading
  • Power market risk management based on range forward contracts – ieeexplore.ieee.org [PDF]
  • Wheat forward contract pricing: Evidence on forecast power and risk premia – ageconsearch.umn.edu [PDF]
  • How Koreans Deal With Foreign Exchange Rate Risk: A Behavioral Law and Economics Perspective on the KIKO Forward Contract – papers.ssrn.com [PDF]
  • The collateral-linked currency forward (CLCF) contract: blockchain-enabled OTC currency forward market infrastructure – jii.pm-research.com [PDF]
  • Bidding strategy under uncertainty for risk-averse generator companies in a long-term forward contract auction – ieeexplore.ieee.org [PDF]
  • On the exit value of a forward contract – onlinelibrary.wiley.com [PDF]
  • Feasibility of a cash forward contract: an application to the French and Spanish potato sectors – onlinelibrary.wiley.com [PDF]