Window Forward: a Worked Example

A forward exchange contract fixes the rate and the date together. An exporter that sells US$500,000 forward for 30 April must deliver US$500,000 on 30 April. If its customer pays on 12 April, the exporter holds the dollars for eighteen days. If the customer pays on 9 May, the exporter has nothing to deliver on the due date, and the bank either extends the contract to a new date at an adjusted rate or closes it out at the market rate, with the difference settled either way. Each of those is a dealing decision, a settlement and, for a business with dozens of receipts a quarter, an administrative load.

Most exporters know the month a payment should arrive far better than the day. A window forward is written for that knowledge: the amount and the rate are fixed, and the date is left open inside a range.

Each date inside a window has its own forward rate, because the interest rate difference between the two currencies builds up day by day. The customer chooses when to deliver, so the bank cannot know which date it is hedging, and it prices the contract on the assumption that the customer will pick the date that costs the bank most. Depending on which way the forward points run, that is the rate at the start of the window or at its end. A longer window usually means a wider gap between the best and worst dates, and so a dearer contract.

The other moving parts are the window's first and last dates, any minimum size or notice the bank sets for each delivery, and the rule that the whole undelivered amount must be settled on the last day. Banks use different names for the product: window, flexible, open or option-dated forward. Whatever the name, the contract remains an obligation. 'Option' refers to the choice of date, not to a right to walk away.

An exporter of merino knitwear, constructed for this page like every figure in it, expects US$1.8m from an overseas distributor in roughly equal payments across March, April and May, paid as containers clear rather than on set dates. Spot is 1.7000 units of home currency per US dollar. In this example home interest rates sit below US rates, so forward rates fall a little across the window: 1.6960 for the end of March, 1.6930 for April and 1.6900 for May. The rates are the example's, not a market quote.

The exporter gives up 5,400 units of home currency so that it does not have to guess the days. By 31 May the distributor has paid US$1.5m and the exporter has delivered each payment against the window as it arrived. The last container is held at the port, and its US$300,000 will not arrive until mid-June. The window closes on 31 May regardless, and spot that day is 1.7400:

The 15,000 is the gap between the contract and the market on dollars that had not arrived. It is not the whole story: when the US$300,000 lands in June it converts at the June spot rate, and at 1.7400 it would bring in 522,000, recovering the 15,000. Had the dollar weakened instead, the settlement would have gone the exporter's way and the late receipt would have converted for less. For two weeks, the late payment was an open position rather than a hedged receipt.

Against a fixed-date forward, a window forward trades a slightly worse rate for freedom over timing, and it removes most of the extensions and close-outs a fixed-date book generates. Against a currency option, the difference is the obligation. An option gives the right to sell at a rate, for a premium paid up front, and suits an amount that may not arrive at all, such as a tender not yet won. A window forward suits an amount the business is confident of, from a contract it holds, whose timing is the only doubt.

To the bank, a window forward is still a forward. It counts against the customer's derivative credit limit for its life, and each delivery is a settlement in which the bank may pay its side before the customer's currency arrives, which is why settlement risk is managed delivery by delivery.

DEFINED IN ONE PARAGRAPH → · A FORWARD, FROM THE EXPORTER'S SIDE → · PRODUCT FILE: FX FACILITY →

A lender reads an exporter's window forwards for how closely they follow its contracts. Windows sized to confirmed orders and timed to the shipping calendar show a business hedging what it will receive. Windows that regularly close with amounts undelivered show receipts slipping behind the plan, and the settlements at each window's end show what that has cost. A run of them is worth more to a credit officer than any single month's figures: it is an early sign that customers are paying later or buying less.

It also bears on how much cover the business holds. A business that has been burned by a fixed date may hedge less than it expects to receive; a window lets it hedge closer to the full amount without betting on days. The lender looks at the result in the hedge cover report, and at whether the business's policy allows the instrument at all.

HOW BANKS READ EXPORTERS → · HEDGE COVER, DEFINED → · HEDGING POLICY →