Forward Market

What Is a Forward Market?

A forward market is an over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery. Forward markets are utilized for trading a scope of instruments, however the term is fundamentally utilized with reference to the foreign exchange market. It can likewise apply to markets for securities and interest rates as well as commodities.

How A Forward Market Works

A forward market prompts the creation of forward contracts. While forward contracts — like futures contracts — might be utilized for both hedging and speculation, there are a few prominent differences between the two. Forward contracts can be redone to fit a client's requirements, while futures contracts have standardized highlights in terms of their contract size and maturity.

Forwards are executed between banks or between a bank and a client; futures are finished on an exchange, which is a party to the transaction. The flexibility of forwards adds to their engaging quality in the foreign exchange market.

Pricing

Prices in the forward market are interest-rate based. In the foreign exchange market, the forward price is derived from the interest rate differential between the two currencies, which is applied over the period from the transaction date to the settlement date of the contract. In interest rate forwards, the price depends on the yield curve to maturity.

Foreign Exchange Forwards

Interbank forward foreign exchange markets are priced and executed as swaps. This means that currency An is purchased versus currency B for delivery on the spot date at the spot rate in the market at the time the transaction is executed. At maturity, currency An is sold versus currency B at the original spot rate plus or minus the forward points; this price is set when the swap is initiated.

The interbank market for the most part trades for straight dates, for example, a week or a month from the spot date. Three-and half year maturities are among the most common, while the market is less liquid past 12 months. Sums are commonly $25 at least million and can go into the billions.

Customers, the two corporations and financial institutions, for example, hedge funds and mutual funds, can execute forwards with a bank counter-party either as a swap or an outright transaction. In an outright forward, currency An is bought versus currency B for delivery on the maturity date, which can be any business day past the spot date. The price is again the spot rate plus or minus the forward points, however no money changes hands until the maturity date. Outright forwards are frequently for odd dates and sums; they can be for any size.

Non-Deliverable Forwards

Currencies for which there is no standard forward market can be traded by means of a non-deliverable forward. These are executed seaward to try not to exchange limitations, are just executed as swaps and are cash-settled in dollars or euros. The most commonly traded currencies are the Chinese remnimbi, South Korean won, and Indian rupee.

Features

• Forward contract pricing depends on interest rate inconsistencies.
• Forward contracts vary from future contracts in that they are adaptable in terms of size and length, or maturity term.
• The most commonly traded currencies in the forward market are equivalent to on the spot market: EUR/USD, USD/JPY and GBP/USD.