How do Forward Contracts Work?

Below is the definition of a forward contract price, formula, and example of how a forward contract is done. This is not forward contracts basics. Please refer to the basics of forward contracts for more fundamental definition where forward contracts are discussed.

Example of how a forward contract works

Spot rate USD/DEM 1.5000
3 month dollar deposits 4%
3 month DM deposits 8%

The Forward price is:

If the forward rate is 1.600

Then you could:

• borrow DM 1,500,000 at 8% and then
• convert it to USD at 1.5000. Then
• you place $1,000,000 on deposit at 4%.
• Sell USD 3 months at 1.6000

USD deposit matures, your profit from the forward contract is: