Calculating the Market Value of an FX Contract

Foreign exchange (FX) contracts are used to lock in an exchange rate for a future currency transaction. The market value (also called the mark-to-market value) of an FX contract fluctuates over time as exchange rates change. Calculating the market value of an FX contract is crucial for assessing potential gains or losses, especially for companies managing currency exposure.

The market value reflects the difference between the contract’s agreed-upon rate (the forward rate) and the current market rate (the spot rate) for the currency pair, adjusted by the notional amount and the time to maturity.

Formula to Calculate the Market Value of an FX Contract

The market value of an FX contract can be calculated using the following formula:

Market Value=(1/SR-1/FR)xNA

Where:
- SR=Spot Rate: The current exchange rate in the market for immediate settlement.
- FR=Forward Rate: The agreed-upon exchange rate in the FX contract for settlement at a future date.
-NA= Notional Amount: The amount of currency being exchanged under the FX contract.

Sample Calculation

Let’s assume a company has an FX contract to buy USD 1,000,000 in exchange for EUR, with the following details:
- Forward Rate: 1.2000 USD/EUR (i.e., the company will receive EUR 833,333.33 in the future)
- Spot Rate: 1.1800 USD/EUR (the current market rate)
- Notional Amount: USD 1,000,000

Using the formula:

Step-by-step calculation:

1. Inverse of the spot rate:  
= 0.84746

2. Inverse of the forward rate:  
  = 0.83333

3. Difference between the two:  
 
  0.84746 - 0.83333 = 0.01413

4. Multiply by the notional amount:  
 
  0.01413 x 1,000,000 = 14,130
 

Market Value: The market value of the FX contract is EUR 14,130.

This value represents the potential gain in EUR if the contract were to be settled today, compared to the agreed forward rate.

To Summarize:

Calculating the market value of an FX contract allows companies to assess the current financial impact of their currency hedges. By comparing the forward and spot rates, businesses can determine if they are in a gain or loss position on their contracts, which aids in better financial decision-making and risk management.

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