With the internet proving to be an ultimate gamechanger, small businesses are now able to carry out transactions at a global level. This makes it very important to work towards reducing currency risk.
However, that itself is not enough. To keep your business and your profits secure, it is important to have a thorough knowledge of foreign exchange and crypto exchange staking.
Read on to find out how the spot and the forward foreign exchange market differ and what are the different ways to hedge against price fluctuations. Read more
Spot Foreign Exchange
When you want to trade immediately, you opt for a spot foreign exchange rate where your trade is processed within two days in general. The spot rate is an indicator of the buyer’s payment expectations when it comes to buying one foreign currency in yet another currency. Generally, these are used for urgent requirements that could be property purchases, deposits, etc.
You also have the option of buying a spot exchange contract to secure an exchange rate for a particular date in the future. Alternatively, you could also choose to pay a small fee to buy a forward contract to sell at a future rate.
Forward Foreign Exchange
A forward foreign exchange rate is essentially an agreement to buy or sell a predetermined amount of foreign currency at a particular price that is to be settled on a set date in the future (closed forward). In some cases, an investor can also opt for settlements over a range of dates in the future (open forward). Remember that contracts are typically used to secure a currency rate when there is an expectation that the price will increase in the future. This is a legally binding contract between two parties.
How does it work?
In case the payment needs to be credited on an urgent basis, there is no choice other than buying foreign exchange from the spot or current market that will be processed immediately. But, if you need to make the payment at a predetermined date in the future, you can buy foreign exchange from the spot or the forward market that will be processed on or around that date.
So suppose you want to buy a property in Japan which will materialize in the next three months, irrespective of how the price moves in this period, in the futures market you will have to pay the agreed-upon rate only.
Advantages
There are multiple advantages to spot and forward exchange, like:
- It helps manage risk, by allowing you to protect the cost of products and services, bought abroad.
- Protect your profit margins on products and services sold overseas.
- Lock in the exchange rate in advance, up to a year.
It also helps avoid the risk of currency fluctuations, called currency hedging.
Given the nuances involved, a layperson should not be involved in the management of foreign exchange. It requires a knowledgeable individual with a background in finance, or an in-house treasurer, or a finance specialist who has an experience in purchasing, operations, and marketing of the business.
