Types of Foreign Exchange Transactions

Types of Foreign Exchange Transactions

by William Adkins   Published on 26 Sep 2017

At its simplest, currency exchange is just the buying of the currency of one country with the currency of another country. Individuals, businesses and traders all engage in various types of foreign currency exchange transactions. Some participants in currency exchange do so as part of business dealings while others speculate on the foreign exchange (Forex) market in hopes of profiting off of exchange rate fluctuations. The main types of foreign currency exchange transactions they employ are described below.

Basic Currency Exchange

If you’ve ever traveled to a foreign country, chances are you’ve used some of your cash to buy euros, yen or whatever the local currency was. The price you paid was determined by the exchange rate between the two currencies. Your purchase is an example of the most basic type of foreign currency exchange transaction.

Currency exchange rates change continuously, mainly in response to demand for one currency relative to others. Demand for a currency in turn is affected by many factors, including differences in interest rates, inflation and monetary policy.

Forward Contracts

Financial institutions and businesses frequently want to protect themselves against possible losses due to changes in exchange rates. The forward contract is a way of doing this. A forward contract is like a futures contract except it is a private agreement, rather than an exchange-traded security. In forwards, one party agrees to buy (or sell) a foreign currency from (or to) another party. The currency is delivered at a future date at a predetermined price. A variation of this is the forward window contract. Instead of delivery on a specific date, the transaction is settled during a “window” of time between two dates.

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