Saturday, September 5, 2009

The forward market for currencies(1)

Knowledge of how the foreign-exchange markets works and the ways in which currency risk can be reduced is indispensable for business managers today. Changes in the relative values of various currencies can wreak havoc with planning by firms engaged in the export or import business. Of Course, the problem of fluctuating currency values is not so serious if payment for goods, services, or securities must be made right away. Spot-market prices of foreign currencies normally change very little from day to day. However, if payment must be made weeks or months in the future, there is considerable uncertainly as to what the spot rate will be for any currency on any given future date. When substantial sums of money are involved, the rational investor or commercial trader will try to guarantee the future price at which currency can be purchased. This is the function of the forward exchange market-to reduce the risk associated with the future purchase and delivery of foreign currency by agreeing upon a price in advance.

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