Spot Market, Forwards and Futures Markets

Spot Market, Forwards and Futures Markets

The spot market is typically meant when someone mentions the foreign exchange market. Companies that need to hedging their foreign exchange risks out to a certain date in the future are more likely to use the forwards and futures markets.

Spot Market

Because it deals in the largest underlying real asset for the forwards and futures markets, spot market forex trading has historically been the largest. Prior to this, the forwards and futures markets saw higher volumes than the spot markets. However, with the introduction of electronic trading and the growth of forex brokers, the trading volumes for forex spot markets increased.

According to their trading price, currencies are purchased and sold on the spot market. In addition to current interest rates, economic performance, attitudes toward ongoing political situations (both domestically and internationally), and expectations for how one currency will perform against another in the future, this price is determined by supply and demand. It is calculated based on these factors. A spot deal is a completed transaction. A specified amount of another currency is received at the agreed-upon exchange rate value in a bilateral transaction when one party provides an agreed-upon currency amount to the counterparty. The payment is made in cash after a position is concluded. Despite the fact that the spot market is sometimes thought of as one that deals with present-day (as opposed to future-day) transactions, the settlement time for these trades is really two days.

Futures and Forwards Markets

A forward contract is a confidential agreement between two parties to purchase a currency on the OTC markets at a future time and at a preset price. A futures contract is a typical contract between two parties wherein they agree to accept delivery of a currency at a later time and at a predetermined price. Futures trade OTC, not on exchanges.

The forwards and futures markets do not deal in actual currencies, in contrast to the spot market. As an alternative, they work using contracts that indicate claims to a particular currency type, a particular price per unit, and a future date for payment.

In the forwards market, contracts are purchased and sold over the counter (OTC) between two parties who agree on the conditions of the transaction. On public commodity markets like the Chicago Mercantile Exchange, futures contracts are purchased and sold based on a standard size and settlement date (CME).

The National Futures Association (NFA) in the US governs the futures market. Futures contracts include certain requirements, such as the quantity of units being traded, delivery and settlement dates, and non-customizable minimum price increments. By offering clearance and settlement services, the exchange serves as a counterparty to the trader.

Both forms of contracts are legally binding and, though they can be bought and sold prior to expiration, are normally settled for cash at the relevant exchange. When trading currencies, risk can be reduced by using the forward and futures markets for currencies. Large multinational organizations typically use these markets to protect themselves from future currency rate swings, although speculators also participate in these markets.

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