Types of foreign exchange trading

Foreign exchange operations..

Foreign exchange trading operations will be explained
with the aid of the next diagram. The type of operation
selected depends on the date set for delivery of
the currency. As a general rule, four types of operations
are used: spot transactions, forward transactions,
swaps and futures.
Spot transactions are the basic type of foreign
exchange operation. Under spot agreements, both
parties fulfil their obligations two working days after
conclusion of the trade. In the old days, the two-day
period between conclusion and execution of the
agreement was required for completion of the accompanying
paperwork. Although this no longer applies
in the same way, the traditional system has been
retained. In principle, spot transactions can also be
concluded for execution on the next working day or
even for the same day. However, in such cases, slightly
modified prices are used instead of the normal spot
prices. The premium/discount to the spot price
depends on the interest rate for the currencies concerned.
Before we turn to transactions covering more
than two working days, let us take a closer look at
how spot transactions work. The various stages to
the settlement of a spot transaction will be illustrated
by means of an example. Let’s assume that a further
decline in US inflation has been announced on the
previous day. A low inflation effects generally a
higher valuation of the underlying currency. Let us
assume that yesterday’s closing rate for the USD/CHF
was 1.3810/1.3820, while New York closed at
1.3855/1.3865 and the exchange rate in the Far East
is currently 1.3860/1.3870. If a bank in, for example,
Frankfurt asks for a quote, the trader will quote a
slightly higher price, for example 1.3865/1.3875. If
no transaction is concluded, it may be assumed that
the bank considered the exchange rate quoted to
be correct. Accordingly the trader will not modify it.
This is what traders call “par” or “parity.”