Forwards is commonly defined as an over-the-counter or exchange traded business that is intended to be dealt through the delivery of a merchandise in the future. With this type of contract, the client is usually given an assurance to avail the said product at an agreed rate. The seller on the other hand is expected to obtain a fixed rate including a sales outlet from the client. There are various types of contracts that have similarities to this option. One of them is called currency forwards. This type of contract is usually utilized in the course of forex tradingtransactions. In this post, we will try to elaborate the central points of this particular contract in order to clarify the reasons why traders use them in the market.
The Nature of Currency Forwards
Currency forwards is an agreement between 2 parties who are involved in a FX transaction. This agreement aims to lock in exchange rates for the benefit of buying or selling currencies on a designated time frame in the future. This instrument is also designed as a material for hedging which does not require an upfront payment for margin.
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Other notable features of Currency Forwards
1.A currency forward does not have the same level of flexibility compared to other derivatives.
2. The contract represents an obligation between the two involved parties to stay still if the lock-in rate becomes adverse.
3. Financial Institutions and Forex trading platforms usually require a deposit from smaller establishments which are not affiliated with them. This deposit is meant to secure cases where non-delivery or non-settlement may happen.
4. Settlement for currency forward deals can be in the form of cash or delivery service.
5. Computations for currency forwards prices are definite. Interest rate differential for the currency pair is used as a basis for computation.
6.Currency forwards are contracts that protect the buyer or seller from unfair exchange rates that may be observed in the course of the deal.
7. This contract is best utilized in situations where
forex rates affect the rates of commodities that are sold in the market.
8.It can also be used when a trader or a corporation intends to buy a property abroad. Sometimes it is also made to deliver payment for the maintenance that are relevant to the purchase of the said asset.
9. This contract does not solely cover trader to trader transactions. Sometimes, it may also involve clients and a financial institution. This agreement may be made when the institution funds vacation or education abroad.
10.Currency Forwards are mostly served to parties who are based in different countries.
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In summary, currency forwards is actually a type of derivative that falls under futures contracts. Despite this, the nature of currency forwards differs from that of the futures contract. Currency forwards are private agreements and it can be manipulated to match the preferences of both parties while a typical futures contract is standardized and with much strict standards.