What Do “Outrights” Mean in the Context of the FX Market?

The term “outrights” is used in the forex (FX) market to describe a type of transaction where two parties agree to buy or sell a given amount of currency at a predetermined rate at some point in the future. Also called a forward outright, an FX forward, or a currency forward, the outright is a tool that companies that buy goods or services overseas in different currencies can use to lock in favorable exchange rates.

Key Takeaways

• Outrights or forward outrights are contracts where two parties agree to deliver a certain amount of currency at a fixed rate at some time in the future.
• Companies that have business activities overseas use outright forwards to lock in exchange rates, stabilize cash flows, or hedge potential losses due to unpredictable moves in the forex market.
• One disadvantage of an outright forward agreement as a hedge is that the currency moves in a favorable direction, and the company doesn’t benefit from the move.

Understanding Outrights

A forward outright transaction is used mainly by importing companies seeking to hedge against adverse currency fluctuations or to stabilize a stream of future cash flows by taking advantage of the current rate. The agreement specifies the fixed foreign exchange rates and a specific date in the future, which is called the settlement date. Some outright forwards require a partial payment at the time of the agreement and then the remainder at the settlement date.

Let’s say a U.S. company known as ZXY imports most of its materials from a supplier in the U.K. every six months and company executives at the U.S. company believe that the value of the U.S. dollar is going to decrease against the British pound. If the dollar does lose value, the weaker currency means that it takes more U.S. dollars to buy the same amount of materials from the company in the U.K.

If the concern is that the dollar will lose value, the importing company might take advantage of a forward outright transaction, allowing two parties to agree on a certain exchange rate today, and when ZXY needs to purchase materials in six months, it will not be affected by adverse changes in the exchange rate.

Disadvantage of Forward Outrights

An outright rate differs from the rate used in the spot market, which is the price that the currency fetches today because the parties factor in characteristics such as the volatility of the currencies and their mutual opinion of where they think the exchange rate will be in the future.

The disadvantage of using a forward outright is that the exchange rate could move in what would have been a favorable direction had the hedge not been implemented.

In this case, the company doesn’t stand to gain from favorable changes in the exchange rate because they agreed to pay a predetermined exchange rate regardless of the rate at the settlement date when the importing company purchases from the overseas supplier.

How Do You Hedge Currency Risk?

To hedge currency risk, you can use a number of financial contracts, including forwards, futures, options, and swaps. The general concept is to lock in a fixed exchange rate for a future date, preventing loss against any adverse currency moves.

What Is the Difference Between a Forward Rate and a Spot Rate?

The difference between a spot rate and a forward rate is that the spot rate is the current market price while the forward rate is the agreed-upon rate at a point in the future. Spot and forward rates are often used in hedging transactions, where two parties agree to transact a specific number of securities at a specific price at a future date. The forward rate will be plus or minus the spot rate.

What Is an Example of Currency Risk?

Say, for example, you are a seller in the U.S. and a buyer in Europe agrees to pay €400,000 for a sale. At the moment, the euro is valued at 95 cents, you would receive $380,000. But if the euro decreases in value at the time of payment to 90 cents, you would receive $360,000; a loss of $20,000.

The Bottom Line

Outrights, or forward outrights, are contracts involving two parties who agree to deliver a certain amount of currency at a fixed rate at a point in the future. This protects against currency fluctuations, which is useful to stabilize costs, particularly in volatile markets, however, it hurts parties to the contract if prices move lower. FX outrights are often used by companies that conduct foreign business to hedge against currency risk.