Currency exchange basics explain how the current prices of foreign currencies keep changing towards its higher and lower values. These exchange rates are affected by the influence of any important event in the economy, politics and nature disasters. Foreign Currency Exchanges are different as compared to all other sectors of the world financial system. While being accessible to a variety of organizations and investors, exclusively high trade turnover creates an ensured liquidity of traded currencies. Foreign currency exchanges have experienced a phenomenal growth in volume ever since currencies were allowed to float freely against each other (Foreign Currency Exchange, 2013). Some of the major factors behind this are the increased volatility of currencies rates and the growing mutual influence of different economies and the advancements of technology (Foreign Currency Exchange, 2013).
Forward Contract.
Forward contracts are contract to buy or sell a precise amount of a foreign currency at an agreed price. This transaction will be paid or settled at a specific date in the future, or, and again this has to be clearly defined, within a period of time in the future. This type of contract is a derivative because its future value is based on the current spot exchange rate (Radebaugh, Gray, & Black, 2006, p.343). According to Robinson (2010), there are three advantages to these types of contracts:.
1. It helps to save guard the cost of imports. As the exchange rate is fixed for the future, currency fluctuations will not affect the price. At the same time the importer will not have to either pre-pay or finance his future import.
2. The effect of this is that profit margins will be saving guarded for those items, product or services, being imported.
3. Time flexibility. The forward periods that can be contracted are up to a year.
The disadvantages to forward contracts is that the physical characteristics of the product can vary and since there is not money exchanging between the parties in the initial contract stage, the risk of default is even higher.
