Let's explore FX forwards, also known as outright forwards, which are essential tools in foreign exchange markets.

FX forwards fundamentally work like forwards on any other underlying assets. They represent an agreement to buy or sell the underlying a currency in this case at a price agreed upon today with settlements occurring at a specified date in the future after the spot date. This settlement date is referred to as the forward date, and the agreed upon price is called the forward price or the forward rates.

Let's walk through an example of a six month Euro US Dollar forward to make this more concrete. On the trade date, the two counterparties agree on the transaction details, including the trade size, tenor, or forward period, and the forward price. The forward period generally starts counting from the spot date, which is typically two business days from the trade date For instance, if today is Friday, March 15th, the spot date would be Tuesday, March 19th. A six month forward from that point would then settle on Thursday, September 19th, assuming it's a valid business day. FX forwards are highly liquid, especially the standard forward periods known as straight dates such as 1, 2, 3, 6, 9, and 12 months.

Why are FX forwards so widely used? Well, in the world of international trade, businesses often face transactional FX risks.

Let's imagine a European exporter that has agreed to sell machinery to a US company for a total contract value of 100 million US Dollars with payments due in three months time. This creates FX risk for the European exporter. If the US Dollar weakens against the Euro over the next three months, the exporter will receive less Euros. When the 100 million US Dollar payment is received and converted into Euros to mitigate this risk, the exporter could enter into a three month Euro Dollar forward contract. This contract locks in an exchange rate for the US Dollar payments, ensuring that the exporter knows exactly how many euros they will receive in three months, regardless of how the US Dollar Euro exchange rate moves in the meantime.

But FX forwards aren't just used for hedging. They're also widely used as speculative tools. Investors might use forwards to bet on expected currency movements for example. An investor anticipating a strengthening US Dollar or a weakening Euro could use an FX forward to capitalize on their expectations without holding the physical currencies.