The foreign exchange market (forex or FX for short) is one of the largest, most exciting, fastest-paced markets in the world. It seems to be easier to understand, compared to the stock market. Chances are you’ve already tried it when you’ve gone on a trip to another country and exchanged some money.Forex (FX) is the market in which currencies are traded. The forex market is the largest, most liquid market in the world, with average traded values that can be trillions of dollars per day. It includes all of the currencies in the world.
There is no central marketplace for currency exchange; trade is conducted over the counter. The forex market is open 24 hours a day, five days a week, except for holidays, and currencies are traded worldwide among the major financial centers of London, New York, Tokyo, Zürich, Frankfurt, Hong Kong, Singapore, Paris and Sydney.
Forex transactions take place on either a spot or a forward basis.
- Spot Transactions
A spot deal is for immediate delivery, which is defined as two business days for most currency pairs. The major exception is the purchase or sale of U.S. dollars vs. Canadian dollars, which is settled in one business day. The business day calculation excludes Saturdays, Sundays and legal holidays in either currency of the traded pair. During the Christmas and Easter season, some spot trades can take as long as six days to settle. Funds are exchanged on the settlement date, not the transaction date.
The U.S. dollar is the most actively traded currency. The euro is the most actively traded counter currency, followed by the Japanese yen, British pound and Swiss franc.
Market moves are driven by a combination of speculation, especially in the short term; economic strength and growth; and interest rate differentials.
- Forward Transactions
Any forex transaction that settles for a date later than spot is considered a forward. The price is calculated by adjusting the spot rate to account for the difference in interest rates between the two currencies. The amount of the adjustment is called forward points. The forward points reflect only the interest rate differential between two markets. They are not a forecast of how the spot market will trade at a date in the future.
A forward is a tailor-made contract: it can be for any amount of money and can settle on any date that’s not a weekend or holiday. Transactions with maturities longer than a year are relatively unusual, but are possible. As in a spot transaction, funds are exchanged on the settlement date.
A future is similar to a forward in that it’s for a date longer than spot, and the price has the same basis. Unlike a forward, it’s traded on an exchange, and can only be executed for specified amounts and dates. With a futures contract, the buyer pays a portion of the value of the contract up front. That value is marked-to-market daily, and the buyer either pays or receives money based on the change in value. Futures are most commonly used by speculators, and the contracts are usually closed out before maturity.
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