IntroductionAccording to Moffett, Stonehill, and Eiteman, (2003) a market is a place where buyers and sellers come together to facilitate the exchange of goods and services. The characteristics of a market is that it deals with the transfer of different types of goods and services, these goods and services are not necessarily owned by the market, and lastly it is not definite for a market to be physically located. A financial market on the other hand is a marketing environment which initiates the buying and selling of different kinds of financial instruments in relation to established rules and regulations.
Examples of financial instruments include currencies, equities and debt securities. Other derivatives of the base entities traded in a financial market include swaps and options, futures, and related financial innovations. Financial markets facilitate the transfer of commodities from the lenders to borrowers so as to meet their personal interests. However, Buckley (2009) emphasizes that financial markets are classified into two that is, money markets and capital markets. The two are distinguished from each other considering the time the assets traded in such markets take to mature.
Foreign Exchange Market is the largest international market which trades in currencies. The report focuses on forward market and spot market and how the two co-exist. Forward market and spot market are classification of foreign market based on future delivery and immediate delivery respectively. Therefore the report seeks to establish the extent to which Forward market predicts the existence of Spot market. The Forward MarketIn the Forward market, an agreement is made between the buyer and seller to buy or sell the desired asset at a future time but a price is agreed upon today.
The transaction in Forward market demands that delivery is made at a future date value of a given amount of currency. The exchange rate to be used at the payment date is set during the agreement while delivery and payment are made upon maturity of the contract (Buckley, 2004). Park and Chen (2006) note that forward Exchange rates in the United States are quoted for value 1, 2, 3, 6, and 12 months. However, actual contracts when desired can be planned to take other lengths.
It is important to note that forward transactions constitute about 9% of the total foreign exchange transactions. Political, economic and technical factors at times may lead to upheaval in the exchange market which eventually results to volatile exchange rates that affect international trade. Forward exchange contract effectively protects both parties from unforeseen exchange rate fluctuations which are likely to occur between the date of the contract and due date for payment. Calculation of the real value of the export and import order can be done on the day of processing, and this makes budgeting and costing to be accurate (Moffett, Stonehill, and Eiteman, 2003). This therefore implies that both the buyers and the sellers can utilize the forward exchange contracts which provide various financial and commercial transactions. Types of Forward Exchange ContractsThere are three types of foreign exchange contracts that exist within the international market.
What differentiates them is the period of the contracts as explained below (Buckley, 2009).