SPOT MARKET & FORWARD MARKET

ORGANIZATION OF THE FOREIGN EXCHANGE MARKET

Two Types of Currency Markets

1. Spot Market

2. Forward Market

SPOT MARKET

In finance, a spot contract, spot transaction, or

simply spot, is a contract of buying or

selling commodity, security or currency for settlem

ent (payment and delivery) on the spot date, which

is normally two business days after the trade

date. The settlement price (or rate) is called spot

price (or spot rate).

PARTICIPANTS BY MARKET

a. commercial banks

b. brokers

c. customers of commercial and central

banks

TYPES OF SPOT RATES

Bid Rate- one currency can be purchased in

exchange for another

Offer Rate- one currency can be sold in exchange

for another

TYPES OF SPOT DEALS

Rand/USD deals

USD/Foreign currency deals

Rand/Foreign currency deals

Foreign currency/Foreign currency deals

MECHANICS OF SPOT TRANSACTIONS

SPOT TRANSACTIONS: An Example

Step 1:

Currency transaction: verbal agreement, U.S.

importer specifies:

a. Account to debit (his acct)

b. Account to credit (exporter)

Step 2:

Bank sends importer contract note including:

- amount of foreign currency

- agreed exchange rate

- confirmation of Step 1.

Step 3: Settlement

Correspondent bank in Hong Kong

transfers HK$ from importers account to

exporter’s.

THE FORWARD MARKET

Definition:

“an agreement between a bank and a

customer to deliver a specified amount of

currency against another currency at a specified

future date and at a fixed exchange rate”.

often 30, 90, 180 days.

PARTICIPANTS

a. Arbitrageurs

b. Traders

c. Hedgers

d. Speculators

TYPES OF FORWARD RATE

Outright Forward

Swap Forward

OUTRIGHT FORWARD

A forward currency contract with a locked-in exchange

rate and delivery date.

An outright forward contract allows an investor to buy

or sell a currency on a specific date or within a range

of dates.

Foreign exchange forward contracts function is a very

similar fashion to standard forward contracts.

For example: A French company that buys materials

from a Chinese supplier may be required to provide

payment for half of the total value of the payment now

and the other half in six months. The first payment can be

covered with a spot trade, but in order to reduce currency

risk exposure, the French company locks in the exchange

rate with an outright forward.

SWAP FORWARD

Is a simultaneous purchase and sale of identical amounts of one currency for

another with two different value dates (normally spot to forward). 

Foreign Exchange Swap allows sums of a certain currency to be used to fund

charges designated in another currency without acquiring foreign exchange risk.

It permits companies that have funds in different currencies to manage them

efficiently.

 swap contract: swap contract is an agreement between two party to exchange a

cash flow in one currency against a cash flow in another currency according to

predetermine terms & conditions.

The difference between a forward contract and a swap is

that a swap involves a series of payments in the

future, whereas a forward has a single future payment.

Two most Basic Swaps are:

Interest Rate Swaps

Currency Swaps

SPOT VS FORWARDSpot Market

If the operation is of daily nature, it is

called spot market or current market.

Handles only spot transactions or

current transactions in foreign

exchange.

The exchange rate that prevails in the

spot market for foreign exchange is

called Spot Rate.

Spot rate of exchange refers to the rate

at which foreign currency is

available on the spot.

Not Quoted in Premium or Discount

Here no specified reasons.

Forward Market•A market in which foreign exchange is bought and sold for future delivery is known as Forward Market.•It deals with transactions (sale and purchase of foreign exchange) which are contracted today but implemented sometimes in future.•Exchange rate that prevails in a forward contract for purchase or sale of foreign exchange is called Forward Rate.•Forward rate is the rate at which a future contract for foreign currency is made.•Quoted in Premium or Discount

•(i) To minimize risk of loss due to adverse change in exchange rate (i.e., hedging) and [ii] to make a profit (i.e., speculation).