Basics of Foreign Exchange Transactions

An Forex transaction is useful tactics to manage the risk which is associated while importing and exporting some goods or services which are converted in foreign currency. Question is how this Forex transaction exactly works?

First when you are entering in to an FX transaction then you have to keep some contract amount with you and two currencies on which you are going to do exchange. These are generally known as currency pair and best part is it should be acceptable by your foreign exchange provider. You have to also decide the maturity date on which you are going to exchange your currency. 

Your FX transaction provider will then decide the exchange rate which is also called contract rate which is totally based on the date and which currency you have nominated. The contract rate is the figure on which you have decided to exchange your currency. When the contract date comes one has to exchange the contract amount with your FX provider at the decided contract rate.

Like other commodities currency value also fluctuates. These are depending up on different factors like rate of interest, supply and demands of the goods or services and economic policy. There are many other factors which also depend on this. On daily basis if you notice there will be a small fluctuations occurs, but if it remains for a longer period of time then they can surely move up and down at very high rate. Meaning of this is very simple that future payments in all this currency will end up in very high costs. This situation can easily be controlled by prefixing the exchange rate. Then in future all kind of buying and selling will be taken care at the decided price for a particular amount.

There are mainly three different advantage of FX forward:

It helps to save the cost of imports. These exchange rate is fixed means there won’t be any currency fluctuations which will affect the price factor. Importer does not have to pre-pay or finance his imports. Another good effect of this is profit margins can be saved easily. Last but not the least but we will get flexibility in time. One can easily decide the forward period and its contract period of one year.

Now, next point is how our provider decides the contract rate? It is decided that exchange rate at which our currency will be exchanged when the maturity date comes. Your currency provider is a person who has to determine the exact contract rate. While deciding they have to consider many different facts like:

Pair of currency decided and time zone decided to trade

What will be the date of maturity?

What will be the foreign exchange rates?

What is the contract amount decided?

What is the volatility of the market that day?

Rate of interest of the bank of the different currency pair.

Rate of contract are decided based on spot exchange rates and what is the value of today’s exchange rates?