Any company or individual with dealings in foreign exchange, whether through imports or exports or through inward or outward investments, lending or borrowing, faces some degree of exchange rate risk. Currency forwards or futures are forward or futures contracts with a foreign currency as the underlying. Thus, a contract for the purchase of US dollars denominated in Indian rupees is effectively a contract on the Indian rupee – US dollar exchange rate (referred to as INR: USD). Currency forwards or futures can therefore also be referred to as exchange rate forwards or futures. The basic pricing and trading structure of currency futures and forwards is not different from examples of equity or commodity futures that were seen in previous chapters, but this chapter will explore some of the special features of currency forwards and futures in greater detail. In the foreign exchange markets, a three letter convention is commonly used to refer to currencies – INR for Indian Rupees, USD for US Dollars, GBP for Great Britain Pounds, JPY for Japanese Yen etc.

Typically, hedging needs of smaller firms and for short durations are served better by standardised exchange-traded futures, whereas larger firms with specialised needs and more long-term hedging requirements often go to the forward (OTC) market. Forward contracts are typically entered into through banks, either directly or through a foreign subsidiary. Many India-based multi-nationals, for example, access INR-USD OTC forwards of various kinds in the Singapore market.