FX Forward Valuation: What Is Your Hedge Worth Before Maturity?

A forward can have a positive value even when spot equals the exchange rate written into the contract. It can also show a profit that the holder cannot collect immediately. The missing pieces are the remaining delivery date, the interest rates embedded in today’s replacement forward, and the terms on which the bank will actually close the position.

For a contract to buy euros, compare the agreed rate with a new forward for the same euro amount and delivery date, then discount the dollar difference. That produces a valuation benchmark. An executable unwind requires the correct bid or ask and any fees; a successful hedge must also be judged alongside the payment it protects.

Start with two promised payments, not a chart return

Consider an existing contract to receive €1,000,000 and pay $1,100,000 in 90 days. Its locked rate K is 1.1000 dollars per euro. This is a hypothetical deliverable forward with a fixed maturity, not a rolling retail FX position or a futures contract. The original rate stays fixed while the market value changes.

Let S be today’s spot rate in dollars per euro, F today’s replacement forward rate to the original delivery date, and D the dollar discount factor for the remaining period. From the euro buyer’s perspective:

V = 1,000,000 × (F − 1.1000) × D

The result is dollars, not pips or a percentage return on margin. A contract to sell the same euros reverses the sign. Changing the quote to euros per dollar also changes which notional belongs in the formula; simply taking a reciprocal and retaining the same million-unit input can value a different trade.

A $25,243 asset—and why spot alone misses it

Assume spot is 1.1200, the dollar rate is 5% and the euro rate 3%, all hypothetical annual simple rates for the same remaining 90 days. Use 90/360 = 0.25, comparable funding and collateral terms, and initially ignore basis, spreads, credit adjustments and fees.

D_USD = 1 / (1 + 0.05 × 0.25)
D_EUR = 1 / (1 + 0.03 × 0.25)
F = 1.1200 × D_EUR / D_USD = 1.12555831

The forward’s value is $25,242.78 using unrounded inputs. An independent check values the two promised payments separately: the present dollar value of receiving the euros is $1,111,662.53; that of paying the dollars is $1,086,419.75. Their difference gives the same answer. The shortcut 1,000,000 × (1.1200 − 1.1000) gives $20,000, but compares today’s spot exchange with a future delivery obligation.

The table changes the inputs at one valuation date; it is not a historical price series. Each row keeps the original contract and 90-day remaining term unchanged.

With spot still at 1.1000, the contract is worth +$5,391.66 under the 5%/3% rates, but −$10,837.10 under 1%/5%. A spot chart alone cannot settle the question. At expiry, discount factors become one and forward converges to the relevant settlement spot; only then does the simple spot-minus-contract-rate payoff apply to this model.

The unwind quote is a separate calculation

Now obtain a hypothetical executable two-way quote of 1.1250 bid and 1.1260 ask for precisely the remaining maturity and €1 million. The existing position buys euros, so its offset sells euros at the dealer’s bid. The original contract receives euros while the offset delivers them; at maturity their dollar cash flows leave $25,000 net receivable.

If the bank agrees to terminate both obligations for cash today using the assumed 5% dollar discount rate, that future amount is worth $24,691.36. A separate $150 fee payable today leaves $24,541.36. That differs from the model midpoint valuation without implying an accounting error.

Using the ask would overstate the maturity receipt by $1,000. Discounting for an original 180-day term instead of the remaining 90 days would also be wrong. A fee due at maturity must be discounted with the cash flow rather than treated as an identical fee payable now. Ask for the actual settlement amount, date and currency, not just an attractive replacement rate.

Why a profitable forward need not be an extra profit

Suppose the original purpose was to hedge a €1 million invoice due on exactly the same date. In the frictionless example, the euro liability’s current dollar value is $1,111,662.53. Deducting the forward asset of $25,242.78 leaves a net payment value of $1,086,419.75—the present value of the locked $1.1 million payment.

At maturity, paying $1.1 million under the forward produces the euros needed for the invoice. Celebrating the derivative gain while ignoring the higher dollar value of the invoice counts only the pleasant half of the hedge. This economic reconciliation does not determine how a company must present hedge accounting or tax.

If the invoice is cancelled, reduced or postponed, the forward does not automatically change with it. Closing a derivative while retaining the invoice restores currency exposure; retaining the derivative after cancellation creates unmatched exposure. Moving a payment 30 days later requires a new date-matching assessment, not merely a relabelling of the old deal.

Where the clean formula stops being a cash promise

The two-rate formula is a deliberately simple replication benchmark. Actual market forwards can embed cross-currency basis, credit limits, collateral terms and liquidity costs. Where a reliable executable same-date forward is available, first compare against that quote; do not replace a market curve with two policy rates and call every difference a mispricing. The distinction between forward points and the final exchange rate matters when reconstructing the quote.

A second trade with a different counterparty may offset exchange-rate exposure economically without cancelling either legal obligation. Net settlement, early termination and collateral return require the applicable agreement and confirmations. Collateral already posted must be reconciled separately rather than added to valuation profit a second time. Non-deliverable forwards have fixing and settlement conventions that need their own cash-flow calculation.

A five-line reconciliation before accepting a close-out

1. Copy the original receive/pay currencies, fixed amounts, rate and contractual delivery date. Establish the holder’s direction.
2. Match a new quote to the remaining date, size and settlement terms; record its timestamp and executable bid or ask.
3. Calculate the future net difference, discount only the remaining period, and separate fees by payment date.
4. Reconcile the bank’s present cash amount with collateral, credit or funding adjustments; identify each difference rather than forcing a midpoint match.
5. Recheck the invoice or asset being hedged. Confirm what exposure remains after the proposed termination or roll.

The useful answer is therefore three numbers, not one: a model value, an executable close-out amount, and the combined value of the hedge plus its underlying exposure. Confusing them is how a correct exchange-rate calculation turns into the wrong cash decision.