Foreign Exchange Instruments – what every trader needs to know about them

Foreign Exchange Instruments – what every trader needs to know about them

The FX market is the trading of currencies. But do you know how many alternatives you have at your disposal should you be tempted to try it out?

Short answer: quite a few. In this second part of our series on financial instruments, we will talk about Forex Exchange Instruments and their 5 primary types: spot, options, forward, swap, and futures.

Foreign Exchange Spot (FX Spot)

The FX spot transactions involve a settlement between two counterparts and are pretty easy to understand. Here's what they have in common:

· A direct exchange between two currencies

· The transaction doesn't include interest

· The shortest of all transaction timeframes, with a duration of maximum 48 hours

· The exchange rate used in FX spot – spot exchange rate

Foreign Exchange Option (FX Option)

Options fall into the derivatives category (financial instruments whose values depend on underlying variables). They give people the right, but not the obligation, to exchange one currency for another at a predetermined price and date.

Investors are not limited to option trading on Forex, as the other markets offer this type of trading. However, options trading on currencies appears to be the most popular due to FX being the most liquid market globally. According to the Futures Industry Association (FIA), global futures and options trading grew by 32% to record-setting 21.9 billion contracts in the first half of 2020 compared to 2019.

#FX options trading takes place over-the-counter (OTC). People use if for both hedging (risk mitigation) and speculation, like CFDs trading.

Foreign Exchange Forward (FX Forward)

FX forward contracts represent agreements between two counterparts where they agree to carry out a predetermined transaction at a future date. The transactions consist of one party buying a pre-set amount of one specific currency for a predetermined amount of another currency.

Usually, there is no exchange of money until a pre-established future date has been arrived at, and that’s the thing differentiating forward contracts from the rest of the pack.

Forwards can act as a hedging instrument used to manage risks in the investment activity, similar to the other types of FX exchange instruments.

Foreign Exchange Swap (FX Swap)

According to finance-treasury.com, a foreign exchange swap (FX swap) is not the same as a currency swap.

Foreign exchange swaps (FX swap or Forex swap) function as a simultaneous purchase and sale of the same amount of one currency for another.

Currency swaps function as an agreement to make a currency exchange between two foreign parties.

They swap principal and interest payments on a loan taken in one currency for principal and interest payment of a loan of equal value in another currency. Currency swaps can mature in up to 30 years, which can make them suitable on long-term investments.

Foreign Exchange Futures (FX Futures)

FX futures contracts fall into the forward transaction category. People trade them on special exchanges created for them, and they boast a duration of up to 3 months. Note that futures contracts include the interest rate.

An FX future is a futures contract facilitating the exchange of one currency for another at a pre-set exchange rate and date. Traders use them for both hedging and speculation purposes.

For historical reasons, the U.S Dollar is always the base currency for #FX Futures, the most traded currency globally (streetdictionary.com).

At CAPEX.com, you can trade CFDs on more than 55 currency pairs, from majors, minors, and exotic!

The major currency pairs include two of the following currencies USD, EUR, JPY, CAD, GBP, CHF. Examples: USD/JPY, EUR/USD, GBP/USD.

The minor Currency pairs include one of the currencies mentioned in Major currency and another currency not mentioned there. Examples: GBP/CAD, NZD/JPY, EUR/AUD.

Exotic pairs consist of a major currency and an emerging-market economy currency. Examples: USD/ZAR, EUR/HUF.

Visit our FX page to learn more about trading currencies!

Also, make sure you stay tuned to CAPEX.com Featured Articles for more educational content!

Sources: investopedia.com, streetdictionary.com, thebalance.com, finance-treasury.com

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