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May 2012
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Understand basics of Forex market with examples

”Forex” stands for foreign exchange and it’s also known as FX. Foreign Exchange market or Forex Market is the market in which currencies are traded. In a Forex trade you’re exchanging the sold currency for the one you’re buying.
E.g. – If a UK Company wants to purchase electronics from china than he has to pay that Chinese company in Yen. For this the UK Company has to exchange the equivalent value of Pound sterling with Yen. Foreign exchange helps the business by converting one currency into another.
Forex market is the most liquid form of market and thus is the largest market. It operates 24*7 due to different time zones of different companies and five and half days a week.
E.g. – When the Trading days ends in New York trading starts afresh in Tokyo.
The Forex market is not a centralized market and dealings are conducted over-the-counter i.e. through telephones and electronic media. Due to decentralization the market allows the traders to choose from a variety of dealers thus helping in the getting the best trade price. Traders may include large bankers, currency speculators, organizations, foreign institutional investors, Government, etc.
Spot, Forward’s contract, Future’s contract and Swaps are the financial instruments for dealing in Forex market.
• Spot – is where deal is done then and there. Currencies are traded at the current price. Price is determined by the demand and supply and other various factors. Forex trading in the spot market is the largest.
E.g. – you buy a computer and pay for that at current price though you may get the delivery after few days.

• Forward contract- Speculators use Forward contract to book future loss or profit. In Forward’s contract the deals are customized to meet the customers need. Terms of agreement are determined by the parties themselves.
E.g. – If a company knows that it will need 10 barrels of oil in next month but predicts that the price will increase in the coming month. It can enter into contract with the exporting company now for a future point of time for that particular quantity at a fixed price.

• Futures contract– There is not much difference between Futures contract and Forward contract. In Futures market the deals are standardized. Futures contract are settled in public commodities market and the exchange acts as the counterparty to trader providing settlement and clearing.
• Swaps – In swaps two parties exchange currencies for a particular time and agree to reverse back the transaction at a fixed later date. The terms and conditions of swaps are determined by the parties themselves.

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