Tuesday, September 4, 2007

The Foreign Exchange Future Market: A Good Mechanism

First things first, what is a Foreign Exchange Market for futures contract. In the United States, this type of contract basically means that it is an agreement wherein both parties agree to buy and/or sell a particular currency (not the USD) at a specified price on a specified date in the future, as according to a standard contract that is agreed by all the participants involved in such a currency exchange.

In such an agreement, it is important to know that none of the parties are really selling or buying any one thing. What is being agreed on is that both parties definitely agree to sell or buy currencies on terms that have already been agreed on and at a specified date in the future, that is if the contract reaches maturity. Although, it does so rarely.

Another matter to take into consideration as well as be aware of is that a Foreign Exchange Market futures contract is basically similar in concept to that of a forex forward contract. What is similar to both is that they are agreements that specify that a particular amount of a particular currency is to be bought and sold on a certain future date. Their difference lies on the following: the futures contract is publicly traded, however the forward contracts is traded in an over the counter fashion.

In a futures contract, the currency terms are made in standard form and of which could be traded and are all subject to specific rules in trading of a particular exchange with regards to limits in the daily price.

A future contracts is also adjusted everyday, as there are maintenance and initial margins as well as settlements in cash.

Meanwhile, a forward contract is customizable so that it would be able to meet the needs of customers. In this type of contract, payment via cash is not required (though a collateral could be needed). In this type of contract, the agreement is made by two parties directly, with the absence of a clearinghouse.

Basically, a futures contract could then be seen as a series or a portfolio of forwards, with each day covering a period that is longer, or one that is in between settlements in cash.

Therefore, it is the futures foreign exchange market that, in the end, provides an effective mechanism wherein users could very well alter positions in portfolio in ways that is different than the conventional spot or cash market. Thanks to the futures market, it therefore facilitates risk transfer. Another add-on is that the market of forex futures contributes much to information and discovery of prices of market functions.

Meanwhile, there also exists options in currency that are exchange-traded. Transactions that arise from such a trade are made through clearinghouses of the particular exchange where they are traded. The clearinghouse then guarantee a particular party against the others default.

In this particular transaction, there also exists the buyer-option, this entitys role is that once the premium has been paid by him or her, there also no longer exists any obligation for such a trade, financially speaking. For this person, margin payments are no longer necessary.

Fortunately or unfortunately, it is an entity called option-writer that carries the risks as it is this person that is basically required to put a margin initially as well as on additional payments. That is if the price market moves opposite to what his position is.

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