In: Finance
What is the spot market for FX? What is the forward market for FX? What is the position of being net long in a currency?
Spot markets differ from futures markets in that delivery takes place immediately. Spot prices are the prevailing market prices market prices for each currency. There are no arrangements of future contracts like in forwards or futures.For example, if you wish to purchase Company XYZ shares and own them immediately, you would go to the cash market on which the shares are traded (the New York Stock Exchange, for example). If you wanted to buy gold on the spot market, you could go to a coin dealer and exchange cash for gold.
A foreign exchange spot transaction, also known as FX spot, is an agreement between two parties to buy one currency against selling another currency at an agreed price for settlement on the spot date. The exchange rate at which the transaction is done is called the spot exchange rate. Similarly, if you wish to trade in FX, there are number of different market participants like traders,brokers, dealers etc. You can buy and sell at spot prices which keeps fluctuating throughout the day.
A forward market is an over-the-counter marketplace that sets the price of a financial instrument or asset/currency for future delivery. It is a customized contract between two parties.
Consider the following example of a forward contract. An Indian software company INFOSYS which sells softare to USA will receive their payments in USD, But it will have to convert it to INR in order to use the cash for their business operation in their headquarters in India. So there is a prevailing currency conversion risk. In order to hedge this risk Infosys might enter into a currency forward contract in which they decide to sell 1 million USD after 1 month(Which they'll receive from the American company) at INR 60 in case they feel the INR will depreciate. These contracts are not traded over an exchange and are entred through financial intermediaries like investment banks and other brokers.
Interbank forward foreign exchange markets are priced and executed as swaps. This means that currency A is purchased vs. currency B for delivery on the spot date at the at the spot rate in the market at the time the transaction is executed. At maturity, currency A is sold vs. currency B at the original spot rate plus or minus the forward points; this price is set when the swap is initiated. The interbank market usually trades for straight dates, such as a week or a month from the spot date. Three- and six-month maturities are among the most common, while the market is less liquid beyond 12 months. Amounts are commonly $25 million or more and can range into the billions. This is exactly similar to interest rate swaps in Bonds/Debentures.
Customers, both corporations and financial institutions such as hedge funds and mutual funds, can execute forwards with a bank counter-party either as a swap or an outright transaction. In an outright forward, currency A is bought vs. currency B for delivery on the maturity date, which can be any business day beyond the spot date. The price is again the spot rate plus or minus the forward points, but no money changes hands until the maturity date. Outright forwards are often for odd dates and amounts; they can be for any size.
The most commonly traded currencies in the forward market are the same as on the spot market: EUR/USD, USD/JPY and GBP/USD.
When it comes to trading securities in whether a spot/forward or derivative markets, there are two types of positions.
1. Long position - A long (or long position) is the buying of a security such as a stock, commodity or currency with the expectation that the asset will rise in value.
2. Short position, is a directional trading or investment strategy where the investor sells shares of borrowed stock in the open market. The expectation of the investor is that the price of the stock will decrease over time, at which point the he will purchase the shares in the open market and return the shares to the broker which he borrowed them from.
An FX investor usually takes a lot of different positions(long and short) in different currencies with similar returns and risk to particularly to hedge risk.
Net long refers to a condition in which an investor has more
long positions than short positions in a given asset, market,
portfolio or trading strategy. Investors who are net long will
benefit when the price of the asset increases.
Net long is a term used broadly across the investment industry.
Investors and market traders can take either a long or short
position on an investment. Long positions are typically taken by
bullish investors and short positions are associated with bearish
investors. Net long can be a calculation of a single position or it
can refer to an entire portfolio comprehensively. It can also
generally refer to a market view.
Investors take a net long position when they buy and hold
securities for the long term. A net long position can also occur
from multiple investments. Mutual funds often have the option to
take both long and short positions to achieve the targeted
objective of the portfolio. Therefore, the net long position would
typically be calculated by subtracting the market value of short
positions from the market value of long positions. In a net long
portfolio the market value of long positions is greater than short
positions. Some mutual funds may be restricted from short selling,
which means 100% of the securities are bought and held for a full
net long position.