Legal Definitions - forward agreement

A forward agreement (often referred to interchangeably as a forward contract) is a private, customized agreement between two parties to buy or sell an asset at a predetermined price on a specified future date. Unlike standardized contracts traded on public exchanges, forward agreements are negotiated directly between the parties involved. This allows for significant flexibility in tailoring the terms, including the specific asset, quantity, price, and exact delivery date, to meet their unique needs. The primary purpose of a forward agreement is often to lock in prices or mitigate risks associated with potential future price fluctuations of commodities, currencies, interest rates, or other financial assets.

• Example 1: Hedging Currency Risk for International Trade

  A Canadian software company expects to receive a payment of 500,000 Euros from a client in Germany in three months. The company is concerned that the Euro might weaken against the Canadian Dollar by then, reducing the value of their payment when converted. To protect against this risk, the Canadian company enters into a forward agreement with its bank. This agreement specifies that in three months, the bank will buy 500,000 Euros from the company at a fixed exchange rate, agreed upon today. Regardless of the actual exchange rate in three months, the company knows exactly how many Canadian Dollars it will receive.

  How this illustrates the term: This is a forward agreement because it's a private, customized contract between the software company and its bank to exchange a specific amount of currency (Euros for Canadian Dollars) at a future date for a price (exchange rate) that is fixed today. It helps the company manage its financial risk by providing certainty about future cash flow.

• Example 2: Securing Future Agricultural Supply

  A large bakery chain in the United States anticipates needing a significant quantity of wheat flour for its production in six months. To ensure a stable supply and predictable cost, the bakery enters into a forward agreement directly with a wheat farmer. Under this agreement, the farmer commits to selling a specific tonnage of their future wheat harvest to the bakery at a fixed price per bushel, to be delivered upon harvest in six months. This arrangement benefits both parties: the farmer secures a buyer and a guaranteed price, while the bakery locks in its raw material cost.

  How this illustrates the term: This demonstrates a forward agreement as it's a direct, customized contract between the bakery and the farmer to buy and sell a commodity (wheat) at a future date for a price determined today. It provides price stability and supply assurance for both the buyer and the seller.

• Example 3: Managing Raw Material Costs for Manufacturing

  An automobile manufacturer plans to launch a new electric vehicle model in one year, which will require a substantial amount of lithium for its batteries. Concerned about potential volatility in lithium prices over the next year, the manufacturer enters into a forward agreement with a lithium mining company. The agreement stipulates that the mining company will deliver a specified quantity of lithium to the manufacturer on a particular date in one year, at a price per kilogram agreed upon today. This allows the manufacturer to budget for its future production costs with greater certainty.

  How this illustrates the term: This is a forward agreement because it's a private arrangement between the automobile manufacturer and the mining company to buy and sell a raw material (lithium) at a future point in time for a price established at the time the agreement is made. This helps the manufacturer stabilize its input costs and plan its budget effectively.