Average Rate Forwards and Options are FX derivative contracts that are similar to cash-settled forwards and options with the main difference being the rate at which the contract is settled. Instead of the rate observed at one defined observation point, Average Rate contracts take an average of several observations in a defined period – for instance, daily observations in a given month. The contract then pays the net difference between the contract rate and the calculated average forward rate, which tends to be more stable than taking a single observation thanks to the averaging effect.
Average Rate contracts are particularly useful for hedging multiple cashflows that happen at various points in time during a given period reducing volatility coming from foreign currency Accounts Payables or Accounts Receivables.