The Forward Currency Exchange Market

1900 Words4 Pages

The Forward Currency Exchange Market

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 contracts are used on a regular basis. This airline operates to and from countries and small islands around the Pacific. Air Rarotonga operates its business dealings using New Zealand Dollars, that is they sell their plane tickets, pay salaries and run day to day business transactions using New Zealand Dollars. As with many airlines around the world they must pay for their aviation fuel in U.S. Dollars, therefore exposing them to exchange rate risk between their New Zealand Dollar income stream (from the s...

... middle of paper ...

...change XML Data. Retrieved 21st April, 2006, from: http://www.ny.frb.org/xml/fx.html

The Federal Reserve Board. (2005) The Global Saving Glut and the U.S. Current Account Deficit. Retrieved 20th April, 2006, from: http://www.federalreserve.gov/boarddocs/speeches/2005/20050414/default.htm

USA Today.com. (2005) Returns from improved U.S.-Europe relations. Retrieved 23rd April, 2006, from: http://www.usatoday.com/news/washington/2005-04-05-us-europe_x.htm

VOA News. (2005) Survey: Negative Views of US, Bush Still Prevail in Europe. Retrieved 23rd April, 2006, from: http://www.voanews.com/english/archive/2005-07/2005-07-28-voa65.cfm

Wikipedia. (2006) Forward Rate Agreement. Retrieved 19th April, 2006, from: http://en.wikipedia.org/wiki/Forward_rate_agreement

Wikipedia. (2006) Speculation. Retrieved 20th April, 2006, from: http://en.wikipedia.org/wiki/Speculation

Open Document