Financial Instruments

There are several types of financial instruments commonly used.

Forwards
One way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years.

Futures
Foreign currency futures are forward transactions with standard contract sizes and maturity dates for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Swaps
The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not contracts and are not traded through an exchange.

Spot
A spot transaction is a two-day delivery transaction for most currency pairs (but one-day for USD/CAD and some others), as opposed to the futures contracts, which are usually three months. This trade represents a direct exchange between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the Spot market.