FOREIGN EXCHANGE MARKET

Foreign Exchange Currency Market

Foreign Exchange Currency Market

Introduction

The main purpose of this paper is to discuss the reduced risk in foreign exchange currency market using future and forward contracts. This paper makes discussion on the issue that how future and forward contracts can help in the risk reduction in foreign exchange currency market. The paper also discusses the difference in the application of the future and forward contracts.

Usage of forward and future trading has a long history in order to make improvements in the commercial market place. In history, people used the forward and future contracts for their farming purposes. The farmers used these contracts to avoid the complications in the financial markets. It is been centuries that people are using the commodity market in order top trade their products (Burnside, 2001a, p. 98).

The first formal future trading started in U.S. New York for grains, but they properly developed in Chicago in 1840s. Afterwards, the future and forward contracts became the mode of contracts throughout the world (Daniel, 2001, p. 293).

The future trading has originated from the former practices of trading and makes negotiations on the commercial agreements which are termed as the forward contracts. Forward contracts started with the start of commerce practices. These agreements were used as the transactions of only the physical commodities in the past. Thus, it can be said that future and forward trading are present in the business world since the start of the business transactions.

Forward Contracts

A forward contract is a written agreement between the participants in the forex industry. A trader can use a forward sale contract to lock in a fixed forward price and hence get a guaranteed return for his effort in trading. Generally speaking, trader's interest in a forward contract is high when currency prices have been low for a prolonged period and the interest is low when hog prices go high. Traders are also attracted by a partial prepayment or credit advance in some contracts. In that case, they can finance their purchase of inputs by the prepayment (Corsetti, 1999, p. 305).

I. Forward Sale Contracts: A forward sale contract is created when a contractor agrees to pay a specified price for a certain number of markets to be delivered at a determined future date and location. These contractors normally, then use the futures to hedge their market position by selling an equivalent quantity of contracts. When currencies are delivered under the contract, the contractor offsets the futures position by buying back the futures contracts previously sold. For that reason, it requires the minimum number of contracts. In most cases, partial prepayment or credit advanced by the contractor are available.

Future Contract

A futures contract is known as a contract between two parties, to buy or sell a quantity and type of specific asset at a certain time in the future at an agreed price at the time of contract in the futures exchange.

The process of selling or buying a futures contract is not a real ...