A forward exchange contract (FEC) is an agreement between two parties to exchange one currency for another currency at a specified point in the future, at a predetermined rate. FECs are used as a hedge against risk of loss due to fluctuations in the currency markets and to protect both parties from exposure to untraded or even non-convertible currencies.

Forward exchange contracts are typically related to a specific currency pair which is not accessible on the popular spot markets or foreign exchange (FX) markets. In other words, if you are trying to trade a currency pair that is not readily available, you would have to enter into a forward exchange contract in order to complete the transaction. As FECs are not available on the spot market, the terms and conditions are usually negotiated between the two parties and customized to the specific situation. This gives companies the flexibility to craft a contract that meets their specific needs, making it highly advantageous for hedging of FX risk.

FECs can potentially help protect a company from foreign exchange risk. This is because a forward exchange contract is essentially setting a future rate at the time of entering into the agreement. Since the future exchange rate is known, it provides protection for companies from adverse future spot rate movements, which may otherwise occur if the FX market does not offer the desired currency pair. This can be a critical element of international business planning.

Overall, a forward exchange contract is a complicated but often useful tool for FX trading when liquidity or access to certain currencies is not available. Companies can use FECs as an effective risk management tool, while having the flexibility to negotiate the terms and conditions of the contract. FECs therefore provide stability, protection against risk of loss due to currency price fluctuations, and a peace of mind.