A currency futures contract is a contract to buy or sell currency at a specific price on a future date. This contract is used to hedge against foreign exchange risk by fixing the price at which a currency can be obtained.
A futures contract is traded on an exchange, so it has a standard amount, expiry date, and settlement rules. An initial deposit into a margin account is required to initiate a futures contract. The contract is then repriced (marked to market) each day, and if cumulative losses drain the margin account, a company is required to add more funds to the margin account. If the company does not respond to a margin call, the exchange closes out the contract.
Currency futures are most heavily traded on the Chicago Mercantile Exchange (CME), where trades are largely centered on the exchange rates between major currencies, with much lower trading volumes on contracts involving the currencies of emerging markets.
Given that futures contracts are standardized, they may not exactly match the timing and amounts of an underlying transaction that is being hedged, which can lead to over- or under-hedging. For example, a company may need to hedge a projected receipt of 550,000 pounds, and the related futures contract only trades in units of 100,000 pounds. If so, the company can either under-hedge by selling five contracts (which hedges 500,000 pounds), or over-hedge by selling six contracts (which hedges 600,000 pounds). Also, the standard expiry date on a futures contract will likely differ from the termination date of the underlying transaction, which exposes the company to foreign exchange risk during those days when there is no hedging position.
However, since these contracts are traded on an exchange, it is easier to trade them than forward contracts, which allows the treasury staff to easily unwind a hedge position earlier than its normal settlement date.
In a forward contract, the bank includes a transaction fee in the contract. In a futures contract, a broker charges a commission to execute the deal.