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.
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 settlement date.
- 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.
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 makes the purchase from the overseas supplier.