Foreign Exchange and Currency Trading

[Page 1] [Page 2]

Foreign Exchange Transaction Types

There are four main types of foreign currency exchange transactions:

Spot Rate

The spot rate is the current exchange rate of one currency for another at the present moment in time. In the spot market, transactions happen immediately at the quoted price.

Forward Contracts

A forward contract is an agreement to buy or sell a specified amount of currency at a specific exchange rate on a certain date. This contract will often be between a large multinational business and a commercial bank.

Currency Futures

A currency futures contract works in pretty much the same way as a forward contract, except that they are for a standard volume of a particular currency (i.e. xxx units) and are sold on an exchange. In other words, forward contracts are unique agreements between a commercial bank and a company to buy/sell an exact amount of currency on a given date, whereas currency futures are standard 'blocks' of amounts.

Currency Options

While currency forward contracts and currency futures have dates upon which the transaction must take place no matter what, currency options give the right but not the obligation to buy or sell. There are two options: The right to buy (known as a call), and the right to sell (known as a put) a particular amount of a currency by a specific date. As with forwards and futures, the party on one side of the transaction will profit from the deal while the other side will lose out, and, just like forwards and futures, the agreements are legally binding, which means that if one party wishes to exercise their call or put options, the other party must complete their side of the bargain even though they lose out.

Example:

At Time 0 (now), £1 = $2. In one month's time a UK firm is due to make a large payment in US dollars to a supplier. It therefore decides to purchase a call option where it can buy a certain amount of US dollars at $2 = £1 at any time during the next month. If during that month the exchange rate drifted to £1 = $1.60, the firm can exercise its call option and get $2 for every £1 rather than just $1.60 per Pound. If on the other hand the exchange rate moved to £1 = $2.60, the firm could obtain more dollars right now on the spot market than it could get by exercising its call option. Because an option gives you the right but not the obligation to buy, the firm would simply buy on the spot market and let the call option expire.

Become a Currency Trader!

Click the link below to see how you can trade currency in the foreign exchange markets yourself:

Find me some foreign currency trading sites!

Click on one of the keywords below to perform a search for that keyword, or alternatively, use the box below to search the web!

Sitemap