Foreign exchange is the exchange of one currency for another or the conversion of one currency into another currency. Foreign exchange also refers to the global market where currencies are traded virtually around the clock.
The global foreign exchange market is the largest and the most liquid financial market in the world, with average daily volumes in the trillions of dollars. The term foreign exchange is usually abbreviated as “forex”.
The foreign exchange market isn’t exactly a one-stop shop. There are a whole variety of different avenues that a company can undertake when trading or purchasing goods overseas. When you’re making trades in the forex market, you’re basically buying or selling the currency of a country. But there’s no physical exchange of money from one hand to another.
When purchasing or receiving payment in a currency other than sterling a company is taking the risk that the cost of goods or services being purchased or the payment to a supplier is adversely affected by the change in the value of sterling against the various currencies.
There are many unforeseen factors which could significantly adversely affect the value of any currency which in some circumstances could totally erode the profit of any underlining transaction.
Sterling could however improve against various currencies, however the risk lies in the fact that the value of the two different currencies is ever-changing and unpredictable
A company simply purchases a currency on spot (however for most currencies this in practice means two business days). The spot market can be very volatile given that movement in the short term is dominated by technical trading which focuses on direction and speed of movement. Long-term currency moves are driven by fundamental factors such as relative interest rate and economic growth.
A forward trade is any trade that settles further in the future than spot. The forward price is a combination of the spot rate plus or minus forward risk factors as outlined above. Most of these transactions would mature in less than 12 months (a longer period is available on a case by case basis). Like with a spot, the price is set on transaction date, but money is exchanged on the maturity date.
A forward contract is a tailor-made arrangement that highlight currency being purchased, settlement date and charges.
We would recommend that a company exporting or buying goods or services in a currency other than Sterling, to work out the rate they need to achieve the desired profit margin and, considers purchasing the various currency on spot or forward.
Wait for the currency markets to move in your favour or rely upon forecasts. The truth is that nobody knows what is going to happen in any given currency pairing and much of the forecasting from ‘experts’ is guesswork.
1: Identify your currency risk
2. Take time to consider your strategies
3. Trade objectively and without emotion
In addition to banks there are a number of independent foreign exchange who in many cases are in a position to provide a more tailored solution and more competitive charges.