Question

Briefly describe currency spot and forward transactions.  Describe the primary advantages of forward contracts and futures contracts in comparison to each other.

Answer 1

Forward Exchange Transactions can be classified into spot transactiona and forward transactions.

Spot Transactions are contract based transactions that are performed in the Spot market.These are basically current transactions which are entered today and are performed or delivered on the same day or in maximum two business days.The transaction is completed either then and there or in maximum two business days.It is a very popular form of transaction. The spot rate is used for such transactions.The current price of the financial instrument is called spot rate.Spot rate is the rate of foreign currency  which exists on the spot or at the time of enetering into the transaction.The Spot transaction occurs between a buyer and a seller.

Unlike spot transactions, the Forward Transaction is also a contract based transaction to purchase or sell the currency at a pre determined future date.Contract is entered to perform trade in future rather than in present.Such transactions are entered today and implemented or delivered at a future period.Exchange rate used in the forward conmtracts are called Forward Rate.This rate is decided today but the transaction takes place in the future.It is calculated using premium or discount on spot rate. Investor can take either long position or a short position.In long position the investor shall indulge into buying forward contract and in short position the investor shall indulge into selling forward contract.

Future Contracts are legal agreements to buy or sell security/ currency/stock at a pre determined rate in futiure.Future Contracts are standardized and are traded on stock exchange.

Advantage of Forward Contract and Future Contract in comparison to each other :-

1. Future Contracts can be traded on an exchange.Thu Future contracts are more feasible for the investors than forward contracts

2.Forward contracts provide wide variety of transaction options as they are customizable. Investors can transact specific to their needs. Future Contracts lacks flexibility as they are standardied and not customizable.

3.Future Contracts go through clearing house but forward contracts dont.Due to presence of a clearing house future contracts are less riskier than forward contracts..

4. The market of future contracts provides great amount of liquidity , allowing investors to enter and exit whenever they choose to do so.

5. .Forward contracts are negotiated directly between buyer and seller, whereas future contracts are traded on exchange, providing future contracts more stability.

6.Future contracts are market rergulated , but forward contracts are not.This makes future contracts more reliable and atable.

7. Under the forward contracts , the investors have the freedom to choose contract size as per their requirements, however in futures , the contract size is standardized.