Forms of Financial Instruments in a Forward Market
A forward market deals with securities, currencies and commodities that are transacted at a price agreed on at a present date (usually known as a value date) but delivered at a future date at the agreed upon price regardless of any upward or downward changes in the market prices of the financial instruments. Documents that have monetary values or present a binding agreement between the two parties are used. These documents are called financial instruments and examples include spot, forward outright deals, swap, futures contract and options.
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Forward Outright
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A forward outright is a foreign exchange transaction transacted on or before the maturity date when it is traded over-the-counter. It involves buying or selling one currency while at the same time selling or buying another. The buyer and the seller agree on an exchange rate for a date in the future, and the transaction must occur on the agreed date regardless of the changes in the market rates. As a rule, the forward contract is decided by both parties during the time of contract negotiation.
Spot
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A spot (an acronym of single payment option trading) contract is a two-day delivery transaction. There is, however, an exception when trading between the U.S. dollar and the Canadian dollar because the transaction is settled the next business day. The two business days are required in order to enable the trade information between the two parties (buyer and seller) to be processed through the local financial clearing systems. The payments are completed on the agreed date regardless of any changes in the market rates.
Foreign Exchange Swap
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Swap is buying and selling of the same sum of one currency for another but in two different dates. For example, if your need Canadian dollars at a future date and another person needs U.S. dollars, you two can agree to exchange the two currencies at a favorable exchange rate. This will eliminate the risk of changes in the market exchange rate in a way that will be disadvantageous to either party.
Foreign Exchange Option
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A foreign exchange option is a financial instrument that grants the owner the right but not the responsibility to exchange certain amount of money from one currency into another currency at an agreed exchange rate. This is the most liquid market for options of any kind.
Futures Contract
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A futures contract is a foreign exchange transaction agreed at the value date where the exchanges are traded publicly in organized exchange markets. Individuals trade in futures contracts in anticipation for future upward or downward changes in the values of the futures in the markets.
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