What is the difference between a spot transaction and a forward transaction in t

Question

What is the difference between a spot transaction and a forward transaction in the foreign exchange market? A transaction is trade today, and a transaction is trade in the future. What are the key differences between foreign-exchange forward contracts and foreign-exchange futures contracts? contracts are private agreements among traders to exchange any amount of currency on any future date, while contracts are traded on exchanges and are standardized. including a stated settlement date. With contracts, the exchange rate changes continually as contracts are bought and sold on the exchange, and with contracts, the exchange rate is fixed at the time the contract is agreed to Why are forward contracts more widely used in the foreign-exchange market than are futures contracts? Forward contracts are used 10 times more than futures contracts because the counterparty risk between big banks is relatively , and these banks value the of the forward contract.

Explanation / Answer

1. A spot transaction is a trade today and a forward transaction is a trade in the future. Spot transaction will involve immediate delivery of the foreign exchange. Payment is on the spot. Forward transaction involves delivery at a future date (which is pre determined). The contract is entered at the current date. Forward rate is used for forward transactions.

2. Forward contracts are private agreements among traders to exchange any amount of currency on any future date while future contracts are traded on exchanges and are standardized.

Future contracts are standardized, and unlike future contracts the forward contracts are more flexible than the future contracts with regards to the terms and conditions.

3. With future contracts, the exchange rate changes continually as contracts are bought and sold on the exchange and with forward contracts the exchange rate is fixed. Future contracts are marked to market daily as the exchange rate changes continually. Forward contracts have only 1 settlement date and the rate is also fixed.

4. The counterparty risk is low in case of a forward contracts and the banks value the hedge purpose of the forward contract. As no actual money changes hands, the risk is limited to the profit or loss on the contract. Notional value is not involved.

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