Forwards Market in Foreign Exchange
The forward market in foreign exchange is a market where contracts are bought and sold for the delivery of a specific amount of currency at a future date and at a predetermined exchange rate. The exchange rate for the future date is agreed upon at the time of the contract’s creation.
In a forward contract, both parties agree to buy or sell a specified currency at a future date and a predetermined exchange rate. The contract specifies the amount of currency to be exchanged, the exchange rate, and the settlement date. The settlement date is typically between one and twelve months in the future.
Forward contracts are used by businesses and investors to protect against potential exchange rate fluctuations. For example, a business that has an obligation to pay a supplier in a foreign currency can use a forward contract to lock in a favorable exchange rate, reducing the risk of a negative impact on its profits due to unfavorable exchange rate movements.
The forward market is different from the spot market, where currencies are traded for immediate delivery. In the forward market, the exchange rate is agreed upon at the time the contract is created, whereas in the spot market, the exchange rate is the prevailing rate at the time of the transaction.
Practice Questions
1. What is the forward market in foreign exchange?
A) A market where currencies are traded for immediate delivery
B) A market where contracts are bought and sold for the delivery of a specific amount of currency at a future date and at a predetermined exchange rate
C) A market where futures contracts are traded on exchanges
D) A market where options contracts are traded on exchanges
Answer: B) A market where contracts are bought and sold for the delivery of a specific amount of currency at a future date and at a predetermined exchange rate
2. In a forward contract, what is agreed upon at the time of the contract’s creation?
A) The amount of currency to be exchanged
B) The exchange rate
C) The settlement date
D) All of the above
Answer: D) All of the above
3. What is the typical settlement date for a forward contract in the foreign exchange market?
A) Within two business days of the transaction
B) Between one and twelve months in the future
C) The prevailing exchange rate at the time of the transaction
D) None of the above
Answer: B) Between one and twelve months in the future
4. Why do businesses and investors use forward contracts in foreign exchange?
A) To protect against potential exchange rate fluctuations
B) To trade currencies for immediate delivery
C) To trade futures contracts on exchanges
D) To trade options contracts on exchanges
Answer: A) To protect against potential exchange rate fluctuations
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