| Passage 1 The forward market also provides facilities for forward currency transactions. This is a means of enabling the importer or exporter to agree a rate of exchange, now, at which a foreign currency will be exchanged for sterling at a future date, usually one, two, three or six months ahead but sometimes one or two years. This rate is fixed regardless of what might have happened to the rate of exchange in the meantime and is particularly useful in an era of floating, and potentially volatile, exchange rates. If, for example, a British importer of US machines which cost $ 3,000 each has to pay in one month's time he may prefer to buy the currency now for actual delivery in one month's time. With a current rate of $2.00 to the 1 pound the one month rate may be at a two cent premium ($1.98) or 2 cents dearer than the spot rate. These purchases will therefore cost the importer an additional ￡ 15 but at least he knows exactly how much it will cost him whatever happens to exchange rates. If the pound had been devalued or floating down during the month the cost could have horn a lot more than ￡ 15. Theoretically there are two alternatives to buying forward: 1) To buy $3,000 now at the spot rate, pay interest on any loan to pay for the purchase and invest the dollars for one month. 2) Pay the spot rate in one month's time whatever the rate might be. The facility to buy or sell a currency forward, therefore, enables the importer to fix a definite price which will not be affected by fluctuations in exchange rates. Forward exchange markets were temporarily disrupted in 1974 by the collapse of a West German bank which failed to meet its foreign currency obligations. As the foreign exchange markets depend so much on confidence, this collapse led to a temporary contraction in the forward market. However, it has now regained much of the ground lost, indeed in an era of floating rates the forward market is of even more importance to traders in insuring themselves against loss through exchange rate fluctuations. |