I am often confused by FX forward contracts, so this post is mainly to cross check my understanding of a few points.
If I buy a forward contract on USD/EUR:
I am long the contract and I am committed to sell EUR to buy USD at expiration.
I am long USD, short EUR and would benefit if USD/EUR decreases. Because if my commitment is for USD/EUR=1.2 in 1 year and at T=1y the spot is USD/EUR=1, I locked my $1.2.
This would be equivalent to selling/shorting a forward contract on EUR/USD. However, due to quote convention, I am not sure if those exist.
Alternatively, if I sell a forward contract on USD/EUR
I am short the contract and I am committed to sell USD to buy EUR at expiration.
I am short USD, long EUR and would benefit if USD/EUR increases.
This would be equivalent to buying/being long a forward contract on EUR/USD
Are those statements correct?
I guess what bugs me and makes me think that I got it backward is that in the case of a forward contract on e.g. an index, if I am long(short) a forward on SP500, I gain if the index increases(decreases). While on a currency pair, if I am long a forward on e.g. USD/EUR, I gain if USD/EUR decreases. But I always had trouble with currencies e.g. with triangular arbitrage.
Thanks a lot for your reply. This tip makes a lot of sense:
Not “short the foward” but “short the EUR Fwd”
Just to make sure, there:
I sell SGD to buy 1 NZD
you meant I sell 1 SGD to buy 5 NZD, right?
I guess what go me really confused is that I was doing some mock exams and it seemed backward for two questions.
In the first one, an investor needs USD and will receive BRL in the future. He wants to hedge his BRL exposure. While one answer was clearly wrong, the two others were:
long position in an at-the-money call option in BRL/USD (this was the “official” correct answer) => works, because if BRL/USD increases, it means that the BRL depreciated agains the USD so it is hedged.
Short position in a BRL/USD forward => my understanding was this should also work because my contract is to sell BRL to buy USD. However, the answer was:
A short position in BRL/USD is selling USD and buying BRL against USD, the base currency.
The second one was a constructed answer where a UK based investor has assets in HKD far which he wants to implement a minimum-variance hedge. There, one point of the answer was correct:
should short the HKD in a forward contract to hedge the risk of exchange rate fluctuations
But the next one again confused me:
The standard market quote for this currency pair is HKD/GBP. To short HKD, JI should buy GBP, hence a long position in the HKD/GBP forward contract or a short position in the GBP/HKD forward contract.