In a foreign exchange market a currency is traded for another at a rate which is agreeable to both the buyer and the seller. This transaction can happen either over the counter or through an exchange. The rate at which this transaction happens is called the spot rate. Spot rate is applicable for individual who converts local currency for an overseas travel or for a billion dollar payment. As markets are technology driven, the rise in foreign exchange transaction has done at the touch of a button making it the largest financial market in terms of volume. The globalization has helped a small supplier sitting in a far away country sell his products across the world but at the prevailing foreign exchange rate.
How are these rates arrived at?
An Indian corporate may need to convert a currency say US Dollar to Indian Rupee to pay for the cost of manufacturing the product which was sold to the client in US. In a vice versa situation, an oil importer will convert Rupees to US Dollar in order to pay for the oil that he received from another country. All these happen at a particular price. The reference is the spot rate which is traded in the foreign exchange market. These cross border payments and receivables happen at that spot rate.
Spot transactions – the price which is quoted for purchase or sale of transactions which is to be settled within two business days. This is the rate which is the prevailing foreign exchange rate in the market. It is generally referred at T+2. It is the quickest way to exchange currency.
Cash transactions – when then exchange of currency needs to be done now for immediate conversion, the cash rate is quoted. This rate is referred as T. In India T is at a discount of spot rate.
Tom transactions – as the name suggests, the settlement of these transactions happen for the next trading day, so depicted at T+1. Even this is quoted at a discount to spot rate.
Forward transactions – these are transactions done over the counter in which the buyer and seller both enter into an agreement to purchase and sale of currencies at a future defined date. Here, on the basis of a fixed exchange rate on a definite date, the currency is exchanged. Since there is a minimum three day up to one year, there is a premium at which the forward exchange rate is quoted for USDINR. Premium is quoted as there is interest rate difference between the two currency economies – US and India.
Future transactions – quite similar to the forward transactions, future currency transactions are transacted over the exchange and thus have standardized features, size, etc. An initial margin is fixed which is used as collateral to establish future positions.
Swap transactions – swap is buying in spot market and selling in the forward market or vice versa – buying in forward market and selling in spot market. Thus borrowing and lending of two different currencies wherein one borrows in one currency and repay in second currency to other person. Swap transactions are done to pay off obligations without suffering a foreign exchange risk.
Option transactions – every investor has the right to convert the currency from one denomination to another at a predetermined rate on a specific date. The investor is not obliged to do so though. A person can either buy or sell the option terming them as call or put option.
Foreign exchange transactions as hedging tools
All these foreign exchange transactions form a part of the foreign exchange risk management. Thus they are used as hedging tools and strategies are devised around them to minimize any losses that may arise due to fluctuation in the foreign exchange rates.
Forex risk advisors are an important part of finance team personnel who help the corporate to minimize these foreign exchange risks and effectively utilize the hedging tools necessary for enhancing the value of the forex portfolio.
At Myforexeye, the foreign exchange risk advisory is an important value which is added to the corporate’s forex portfolio. From ensuring transparency in sourcing the prevailing forex spot rate to fixing bank margin, devising strategies suitable to the forex cash flows helps to ensure the benchmarks or costing is protected at all times.
Very often, the banks tend to take small and medium enterprises for a ride and misquote the spot rates and premium in the forward markets. The testimonies have proved that advisory services have been beneficial in recovering the cost of these services in one or two transactions by just quoting and negotiating the rates with the bank. Thus cross border payments should not be seen as a separate entity but part of profit center. Thus either forex risk advisors should either be part of the finance team or stand along forex consultants’ services should be taken for the same.
24 Feb 2020 05:08 PM
When they say the currency markets are volatile, it is the spot exchange rate, which is being referred to, which fluctuates within seconds.
07 Feb 2020 03:19 PM
Derivatives market enables access to financial assets for trading at a future date and not just at the market trading date. In currency derivatives the trader agrees to buy or sell a fixed amount of a specified currency at the end.
27 Jan 2020 02:13 PM
Well devaluing a currency can give a thrust to the exports and reduce the trade deficit but for any economy which has higher imports, the consequences can be on the negative too.
16 Jan 2020 05:08 PM
Pegged exchange rate is the fixed rate at which the currency is converted from one to another. The rate is fixed by the monetary authority to order to stabilize the rate of exchange at a predetermined ratio of another currency which is more stable an
03 Jan 2020 04:24 PM
Foreign exchange volatility is what drives the currency market and higher volumes are seen during the high volatile days. In the global foreign exchange market there are unpredictable movements of foreign exchange rates.
26 Dec 2019 05:01 PM
Most traders believe a particular trend in which a currency pair will move and take positions accordingly. Assuming these are well informed and forex educated traders, there are bound to be stop loss levels in place.