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Unit 14: Currency/Forex Market

futures markets tend to be more popular with companies that need to hedge their foreign Notes
exchange risks out to a specific date in the future.

Spot Market

More specifically, the spot market is where currencies are bought and sold according to the
current price. That price, determined by supply and demand, is a reflection of many things,
including current interest rates, economic performance, sentiment towards ongoing political
situations (both locally and internationally), as well as the perception of the future performance
of one currency against another. When a deal is finalized, this is known as a “spot deal”. It is a
bilateral transaction by which one party delivers an agreed-upon currency amount to the counter
party and receives a specified amount of another currency at the agreed-upon exchange rate
value. After a position is closed, the settlement is in cash. Although the spot market is commonly
known as one that deals with transactions in the present (rather than the future), these trades
actually take two days for settlement.

Forwards and Futures Markets

Unlike the spot market, the forwards and futures markets do not trade actual currencies. Instead
they deal in contracts that represent claims to a certain currency type, a specific price per unit and
a future date for settlement.
In the forwards market, contracts are bought and sold OTC between two parties, who determine
the terms of the agreement between themselves.

In the futures market, futures contracts are bought and sold based upon a standard size and
settlement date on public commodities markets, such as the Chicago Mercantile Exchange. In
the U.S., the National Futures Association regulates the futures market. Futures contracts have
specific details, including the number of units being traded, delivery and settlement dates, and
minimum price increments that cannot be customized. The exchange acts as a counterpart to the
trader, providing clearance and settlement.
Both types of contracts are binding and are typically settled for cash for the exchange in question
upon expiry, although contracts can also be bought and sold before they expire. The forwards
and futures markets can offer protection against risk when trading currencies. Usually, big
international corporations use these markets in order to hedge against future exchange rate
fluctuations, but speculators take part in these markets as well.

Notes You’ll see the terms: FX, forex, foreign-exchange market and currency market.
These terms are synonymous and all refer to the forex market.

Self Assessment

Fill in the blanks:
1. The ……………………….. is the “place” where currencies are traded.

2. The ……………………….. market is where currencies are bought and sold according to the
current price.
3. In the futures market ……………………….. contracts are bought and sold based upon a
standard size and settlement date on public commodities markets, such as the Chicago
Mercantile Exchange.

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