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Financial Instruments: forward contracts, options trading etc.

While common traders usually use currency rates as hedging instruments, banks more often apply options, swaps and other, more complicated derivative financial instruments. On financial markets  financial instruments are the methods of conducting financial operations. To figure out what financial instruments (operations) already exist on currency market, let's get through Forex conversion operations.

Forex conversion operation – is the transaction aimed to make an exchange of certain amount of currency belonging to one country into currency of another country as per agreed rate (quote) at a certain date. In other words, it is a common purchase-sale operation, which is called Foreign Exchange Operations or abbreviated as Forex.

A main difference of Forex exchange converter's operations is the settlement date, that is to say, the date when currency is delivered against the date of purchase-sale transaction. According to this criteria, Forex conversion is divided into 2 categories: current conversion operations (of spot type) and forward conversion operations.

 

Conversion operations

 

The market where spot  operations (i.e. as per current rate) take place is called spot market. Operations of spot type are exactly those operations, which are the most popular on the Forex market. Quotes, which many people accustomed to in the window of trading terminal are called spot rate. It is accepted that settlement date for currency conversion operations is the second business day after transaction is made. But it is only related to serious financial agencies. To common Forex traders, trades are made within split seconds, therefore, settlement date cannot be accounted here. As compared with all other Forex conversion operations, spot operations bear the highest risk.

Forward conversion operations include forwards, futures, options and swaps. Listed instruments are also called derivatives. They were made in order to mitigate risks caused by unfavorable change of currency rate in the future.

Forward contracts

Forward contracts are concluded with the purpose of exchanging a certain amount of currency as per earlier agreed price on settlement date, which is also preset earlier. No matter which quotes  will have effect for the settlement date, the contract will be implemented as per earlier agreed price. When in the future unfavorable price is expected, forwards allow using a more favorable rate and thereby minimize one's risks.

Forward contracts are not standardized and not traded on exchanges.

Options trading

Option is much similar to futures, but options trading has its peculiarities. If key feature of the futures trading is the obligation, options provide with the right (but do not bind) to buy or sale an asset in the future as per the price agreed now. One of parties can cancel transaction at own discretion. Options are traded on a separate options market with the purpose of obtaining profit and minimizing risks (diversification). Risk of a specific option contract is rather hard to calculate, because it is changed over the time and in the course of market fluctuations, therefore, only experienced Forex investors and traders are able to speculate with option contract.

 

Futures

Name of this contract is the same as the word "future"; this exchange-traded contract puts parties under obligations to make purchase or sale of goods in the future as per earlier agreed price. In other words, vendor is obliged to sell, whereas purchaser is obliged to buy as per the rate agreed in the contract, but in practice there is no delivery. Parties receive profit or loss depending on price change. Duration of futures' circulation is as a rule 3 months. Futures contracts are standardized and futures trading is conducted on the separate market - futures market. Main difference between forward and futures is that forwards represents a one-time off-the-counter transaction, whereas futures is a repeated exchange-traded proposal.

 

Swaps

This is the sort of forward conversion operations with a simultaneous conclusion of two opposite transactions with different settlement dates. In other words, parties concluded a transaction for purchase-sale with mandatory term to conclude an opposite transaction in an agreed time period. Swap is used to improve the structure of assets and obligations, minimizing Forex trading risks and obtaining profit. Swaps do not have a separate market and are concluded on off-the-counter market. More often, swaps are arranged by financial agents

 

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