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Main reasons for forward foreign exchange markets is to mitigate against transaction
exchange risk by hedging.
3.3.2
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Market Organisation
Forward Contracts greatly facilitate corporate risk management, and bank
traders happily quote forward exchange rates for their corporate and
institutional customers.
12% Outright Forward Contracts, 44% Swaps.
3.4.2
The Bid Ask spreads are wider in the forward market than in the spot market
because the forward market is less liquid.
The liquidity of the market depends on the number of people who are actively.
Trading in the market and on the sizes of the positions they are willing to take.
In very liquid markets, it is easy to find a buyer if you want to be a seller and vice
versa. It is also easy to conduct large transactions without having to provide
concessions to the party taking the opposite side of the transaction. Illiquid
markets are sometimes referred to as thin markets.
Net Settlements
Net settlement is often used in the forex futures market, and for emerging
market currencies. In many emerging markets, there are capital controls in
place, making it more difficult to trade foreign exchange for non-residents.
If the forward price of the euro in terms of dollars (that is, USD/EUR) is higher than the
spot price of USD/EUR, the euro is said to be at a forward premium in terms of the
dollar.
If the forward price of the euro in terms of dollars (USD/EUR) is less than the spot price
of USD/EUR, the euro is said to be at a forward discount in terms of the dollar.
When the first number in the swap points is less than the second number, as in our
earlier example of 15/20, the swap points should be added, and the currency in the
denominator is at a premium.
If there is a discount on the dollar, the first number in the swap price will be greater than
the second number, as in the second example of 20> 15, and the swap points should be
subtracted.
A good rule to remember is that swapping into the currency that is at a premium
generates a positive cash flow.