What Are The Types Of Foreign Exchange?
Foreign exchange transactions are divided into three categories.
The first are spot transactionsfor immediate (actually in two working days) delivery. Spot exchange rates are the prices at which foreign currencies trade in this spot market.
Second, swap transactions are agreements in which a currency sold (bought) today is to be repurchased (sold) at a future date. The price of both the current and future transaction is set today.
For example, you might agree to buy 1 million euros at 0.98 million dollars today and sell the 1 million euros back in six months time for 0.95 million dollars.
The swap rate is the difference between the repurchase (resale) price and the original sale (purchase) price. The swap rate and the spot rate together implicitly determine the forward exchange rate.
The third category of foreign exchange transactions are outright forward transactions. These are current agreements on the price, quantity, and maturity or future delivery date for a foreign currency.
The agreed upon price is the forward exchange rate. Standard maturities for forward contracts are 1 and 2 weeks, 1,3,6, and 12 months. We say that the forward foreign currency trades at a premium when the forward rate exceeds the spot rate in American terms.
Conversely if the spot rate is exceeds the forward rate, we say that the forward foreign currency trades at discount.
Spot transactions form the majority of foreign exchange trading and most of that is interdealer trading.
About one—third of the volume of foreign exchange trading are swap transactions. Outright for- ward transactions account for a relatively small portion of total volume.
Forward and swap transactions are arranged on an informal basis by money center banks for their corporate and institutional customers.
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