Chapter 4 Types of conversion operations

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Types of foreign exchange transactions

The concept of currency exchange transaction is deeply intertwined with the financial terms. We classify the bullion market, the credit market, the security market, and Forex as the financial markets, where financial instruments are the methods of financial transactions. This article reads only about financial instruments which are used on the FX market. Foreign exchange transaction is a deal between Forex market participants to exchange a stated sum of a country’s to the other country’s currency of the other country which has a particular date and price. Foreign exchange transactions are distinguished by the value date. According to this feature, foreign exchange transactions may be divided into two types: spot foreign exchange transactions and forward foreign exchange transactions.

The sheer volume of operations on Forex is spot operations. It is widely accepted that value date of the spot operation is the second working day after the transaction is closed. Such conditions are very convenient for contractors because they have time to process documentation. The market where currency is exchanged on spot quotations is called the spot market.

It should be mentioned that this principle of mutual payment on operations of spot type works for the major investors. For private investors (clients of different brokerage firms), who work on Forex using the Internet, the deal is executed immediately after a trader clicks the button. In such deals value date loses its sense – client’s account always reflects current work on Forex.

Forward foreign exchange transactions include forwards, futures, options, and swaps. They are also called derivatives. Such financial instruments were specially created for business as they help to decrease possible risks made by price fluctuations. For a private investor who wants to make profit on Forex such financial instruments are not very important. Nevertheless, their description will be provided to understand the overall picture.

Forwards or forward contracts are closed between the contractors under the terms and conditions to exchange the certain amount of currency according to the agreed price and day (settlement date). A deal will be closed regardless of the current (spot) prices.

For example, a forward contract may be useful when a Russian company is planning to buy equipment for the US Dollars abroad. Let’s imagine that this company does not have enough funds to close the deal but expects the rubles will be transferred to a settlement account within a month. It also forecasts the rate changes into a negative zone for the company, i.e. the rise of USD. In this situation it makes sense to conclude a forward contract with a bank on buying necessary amount of USD with the settlement date of one month and on profitable for the company price. Of course, it may be difficult to find a contractor because banks also expect the rise of the US Dollar.

On the one hand, Forward contracts minimize risks, but on the other hand, they may drive to profit loss because in case the fall of the US Dollar a company was misses a chance to pay less for the equipment.

Futures, in contrast to forward contracts, have standard maturity dates and fixed amounts of currency volumes. This peculiarity lets them to be sold as common securities. For futures trading there is futures market. The average time of futures circulation is about 3 months.

Options are the same as futures but they reduce liabilities of the contractors. Thus, if you buy futures you have to close a deal according to the agreed conditions, if you buy options you may refuse to close a deal. Options are traded on the options market.

Swaps present foreign exchange transaction when contractors close buy/sell transactions with the liability to execute a reverse deal in a certain period of time. For instance, a company buys from a bank $1,000 for rubles at spot price with the liability to sell $1,000 for rubles back to the bank in a month at spot price which will be on Forex in a month. Swaps are non-standard contracts. That is why they are not traded on the separate market.

Among all described foreign exchange transactions (financial instruments) for a private investor, spot operations are the most important.


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