Forward Exchange

It would be difficult to overstate the importance of the forward market for foreign exchange.  Indeed, a financial manager of a firm with overseas interests may find herself or himself as much involved with this market as with the spot market.  The forward market is valuable for reducing risks arising from changes in exchange rates when importing or exporting and when borrowing or investing in foreign currencies/countries.  Forwards are also used by speculators.  The one-or two-day delivery period for spot foreign currency is so short that when comparing spot rates with forward exchange rates we can usefully think of spot rates as exchange rates for undelayed transactions.  On the other hand, forward exchange rates involve an arrangement to delay the exchange of currencies until some future date. The forward exchange rate is the rate that is contracted today for the exchange of currencies at a specified date in the future.  Forward rates are generally expressed by indicating premium/discount on the spot rate for the forward period. Premium on one country’s currency implies discount on another country’s currency. For instance if a currency (say the US dollar) is at a premium vis-à-vis another currency (say the Indian rupee), it obviously implies that the Indian rupee is at a discount vis-à-vis the US dollar.

Foreign exchange contracts are drawn up between banks and their clients or between two banks.  The market does not have a central location but instead is similar to the spot market, being a decentralized arrangements of banks and currency brokers linked by telephone, SWIFT, and clearing organizations.  Furthermore, the interbank component of the forward market involves continuous two-way open bidding between participants; that is, a so-called “continuous open-bid double auction.”  Each bank, on request, quotes a “bid” and “ask” rate to other banks, valid for that moment.  Foreign exchange brokers play a similar role as in the spot market, serving to match buy and sell orders between potential counterparties.