Foreign Exchange Forwards
Most FX trades settle Spot or T+2 (trade date plus 2 business days). However, you may not need the currency right away and may wish to lock in your rate now. You can access the “Forward” market. FX forwards are when you enter into an FX transaction that settles at some defined date in the future. It could be one week, one month, one year or even five or ten years although that is much rarer. It could also be some specific number of days like 253 days from the trade date.
Forward FX trades are done “Over the Counter.” That means that each one is custom made with the trade counterparty. If you were to enter into a JPY/USD one month forward with Bank of America for instance, they would be your counterparty. They would want to ensure you were a good credit risk, and you would want to ensure that Bank of America was an acceptable credit risk to you. You would have a contract obligating you to buy or sell JPY at a set rate to Bank of America one month from the trade date.
The forward rate is a simple calculation of the spot rate and the relative interest rates available in the two countries for deposits of the same maturity as the forward contract.
Forwards are very flexible and can be custom made for any date, and any amount you need. Most future currency needs are transacted in the forward market. I will address FX Futures in my next post.
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Tracked on: January 26, 2006 5:08 PM | Permalink to Trackback