Forward trading has two instruments: forward outright deals and swaps. A swap consists of two deals (legs) and all the other transactions consist of single deals. In its original form, a swap deal is a combination of a spot deal and a forward outright deal.
Generally, this type of trading includes only cash transactions.
Here are some of its characteristics:
- There are no rules regarding settlement dates, which range from three days to three years.
- Volume in currency swaps longer than one year tends to be light but, technically, there is no impediment to making these deals.
- Any date past the spot date and within the above range may be a forward settlement, provided that it is a valid business day for both currencies.
- It is decentralized, with players around the world entering into a variety of deals either on a one-on-one basis or through brokers. (Currency futures trading is centralized, in which all the deals are executed on trading floors provided by different exchanges.)
- Open to any currencies in any amount. (In futures trading only a handful of foreign currencies may be traded in multiples of standardized amounts.)
The forward price consists of two important parts:
- The spot exchange rate. This is the main building block.
- The forward spread.
This is derived form the spot price by adjusting the spot price with the forward spread. This way both forward outright and swap deals are derivative instruments. Other names for the forward spread are "forward points" and "forward pips". The forward spread is necessary for adjusting the spot rate for specific settlement dates different from the spot date. It holds, then, that the maturity date is another determining factor of the forward price.
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