Which statement about forward exchange contracts is true?

• A. They are simple and flexible to adjust amounts
• B. They are legal contracts between two parties to buy or sell a fixed amount of foreign currency in the future at an agreed upon price
• C. They allow changing the date after agreement
• D. The forward premium/discount is the difference bw the forward price and the spot price

Answer: (B)

Forward exchange contracts are private, legally binding agreements to exchange a fixed amount of foreign currency in a specific future date at a rate agreed now. This captures the essential hedging purpose: you lock in both how much you will exchange and when, at a price you set at the outset. The amount and the date are fixed when the contract is made and aren’t meant to be altered later; that’s why describing forwards as simple and flexible to adjust the amounts is not correct. Similarly, the date is fixed at inception and cannot be changed after the contract is agreed, which is different from the suggestion that you can adjust timing. The idea of forward premium or discount relates to how the forward rate compares to the current spot rate, typically expressed as a percentage reflecting carry costs and interest differentials; simply stating it as the difference between forward and spot prices is a less precise description. So, the statement that best describes a forward contract is that it is a legal agreement to exchange a fixed amount of foreign currency in the future at an agreed price.