What is Forward Booking?

Forward booking is the process of entering into a contract with a booking company, or risk agent, to lock in a specific price for a future date.

Key Takeaways

  • Forward booking is the process of entering into a contract with a booking company, or risk agent, to lock in a specific price for a future date.
  • Forward booking is a method of mitigating the risk of foreign exchange rate volatility.
  • Forward booking is primarily used by companies who do not wish to speculate in currencies when making a significant purchase of an offshore asset.

Understanding Forward Booking

Forward booking is a means of mitigating the risk of foreign exchange rate volatility. The booking company, commonly called a "risk agent," will write up a contract specifying what the rate of exchange will be, and in doing so will assume the exchange rate volatility risk. The contract will also outline a timeline in which the trade must be made. The fee, or transaction cost, associated with the forward book is usually based on a percentage of the amount being traded in the contract.

Forward booking is primarily used by companies who do not wish to speculate in currencies when making a significant purchase of an offshore asset. By agreeing on a rate, the company can easily forecast its expenses and the cost of the asset in local terms. 

For example, a U.S. based company plans to purchase a big ticket item from Germany in six months time that requires payments in euros. The current EUR/USD rate is 1.10, meaning that one euro is worth 1.10 USD. The powers-that-be conclude that the euro will be higher in six months, so they enter into a forward booking contract at the current rate. The booking company, commonly known as the risk agent, would enter into such a contract only if they expect the euro to fall. If the company is correct, then the booking company assumes the loss, which would be the difference between the EUR/USD rate when the contract expires and the specified exchange rate on the contract.

There are some companies who will forward book with a speculative view in the sense that they view it as a favorable time to buy or sell the currency at hand. This is more common in the financial services when a company is buying equities, bonds, or commodities, denominated in a foreign currency. 

Those looking to forward book an exchange rate for the purchase of an asset could also hedge by purchasing an option. Using the example above, the U.S. company could buy a call option for a set amount of euros. If the euro is higher at the time of expiry, then they would exercise the option and, if it was lower, then let it expire and take advantage of the prevailing forex rate.