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.
29 Jun 2020 05:35 PM
Dynamic hedging is a foreign exchange risk management strategy that allows businesses and individuals to readapt their hedging positions to evolving market conditions by providing flexible solutions to protect investments from exchange rate risks.
19 Jun 2020 05:01 PM
Management of Currency Exchange Risk is of paramount importance during turbulent times, like this pandemic. The currency fluctuations are very volatile and cannot be predicted as the circumstances are uncertain.
06 Jun 2020 03:59 PM
Outrights, in FX markets refer to the type of transactions where two parties agree to buy or sell a given amount of currency at a predetermined rate, on a specified date in future.
08 May 2020 05:21 PM
Converting one exchange rate into another at a particular price makes transferring rates. Ideally all nations should be treated as equal and there shouldn’t be any exchange rate applicable which would mean to have a universal currency.
24 Apr 2020 03:08 PM
Managing risk in a financial market is required to keep a check on the adverse movements in the instrument of the market. Particularly in the foreign exchange market.
10 Apr 2020 06:12 PM
So was India’s decision on locking down the country for 21 days required? The implication on the economic growth or rather slowdown has only made many doubt the timing and preparedness of the decision.