The instruments of Foreign Exchange market
All the diversity of world currencies, as well as various derivative instruments of currencies existing today can be attributed to the instruments of Foreign Exchange market. The main trading instruments of Foreign Exchange market are the currencies of various countries. Currency rates, that is to say their relation to the U.S. dollar (or to other currencies) are formed by the supply and demand of the market and also by various fundamental factors. As a rule, the most liquid and freely converted currencies are involved in trading on the Forex market.
The instruments of Foreign Exchange market can be divided into the following two categories:
- Spot - the exchange of currencies no later than the second working day after the date of agreement. These kind of transactions are also referred to as cash. Transactions based on the conditions of spot are made on Over-the-Counter (OTC) interbank market on the basis of the establishment of currency exchange rates (quotes). Speculative currency transactions of banks, hedge funds, financial companies and other participants of Foreign Exchange market are made on spot conditions. Up to 65% of the overall turnover of the Foreign Exchange market falls on trading with the delivery of currencies on the spot conditions.
- Outright forwards – the exchange of currencies at the rate of “forward” within a range of days strictly established by parties of the transaction. Such transactions are beneficial in case of instable exchange of currency rates.
- Currency swap – the simultaneous buying and selling of currencies with different value dates.
Outright forwards and currency swap form Forward Exchange market, where the exchange of currencies takes place in the future.
Derivatives – financial instrument derived from the underlying asset (the main product). Any product or service can be an underlying asset.
- Synthetic Agreement for Foreign Exchange (SAFE) – these are derivatives of the Over-the-Counter (OTC) market, which function as an agreement on the future rate of interest (FRA) in case of currency forward transactions. In other words, this is a guarantee of the exchange rate for a specific period of time, which starts in the future.
- Currency futures – these transactions provide the exchange of currencies on a specific date in the future at the predetermined rate.
- Interest Rate Swap – an agreement between two parties on the exchange of obligations for one currency to the obligations of the other one, in which they pay each other interest rates on the loans in different currencies. In case of the realization of obligations, currencies are being exchanged to original.
- Currency Options – an agreement between a buyer and a seller, granting a buyer the right, but not the obligation to buy a certain amount of currencies on a predetermined price within a specific period of time, regardless of the market price of the currency.