Write an essay on the forward Currency Exchange Market explaining in detail why such a market exists and how it operates; its dealers its buyers, the purposes for which the foreign currency is used. In your answer refer to the forward and futures market instruments explaining how the current exchange rates are affected by movements in these market prices. Use a website to collect information on the forward rate between the US $ and the Euro. Explain what factors have influenced their movement over the past 2 years on a monthly basis
The Reason for the Market
The forward Currency Exchange Market allows interested parties to trade forward contracts on currencies (Madura, 2006, p117). Forward contracts are an agreement between a firm and a commercial bank to exchange a specified amount of currency, at a specified exchange rate and on a specified date. Forward contracts are being used around the world to mitigate the risk of wildly fluctuating foreign exchange rates in day to day business transactions. Firms use the forward contracts when they know they will need a certain amount of foreign currency at a set date in the future, it allows them to lock in a future exchange rate (Wikipedia, 2006).
There may also be a credit risk associated with foreign exchange currency because a ‘buyer’ is essentially promising to purchase the currency on a future date. The buyer may not be able to complete the transaction simply because the funds are not available at the time. So, in cases where commercial bank does not know a company well, and to protect against the credit risk, they require some form of security (such as a mortgage be put forward or a deposit).
Air Rarotonga is a prime example of where and how forward cont ...