Question

Q 1 Explain the difference between spot exchange rates and forward exchange rates. Briefly explain how the forward exchange market works.

Answer 1

Ans

Spot exchange rate shows the no. Of one country's currency units that must be exchanged for other currency units for immediate delivery which is usually within 2 days. On the other hand a forward exchange rate is agreement to exchange an agreed amount of one country's currency in return for a unit of other country's currency for settlement at a mutually agreed future date or range of dates.

In forward exchange market what happens is that two parties reach an agreement to trade various currencies with each other at some future dare and that too at a given rate. E. G I want to import Japanese goods and the supplier will deliver them after 3 months. To protect myself from exchange rate loss due to depreciation of dollar at the time of payment of goods what I will do is to sign an agreement in future market to purchase yen at current spot rate to be settled at the time of payment of goods I. E after 3 months. In this way I don't unnecessarily bind my money for 3 months and still save myself from depreciation of dollar