Exchange of goods and services can be broadly categorized as domestic and foreign exchange markets. The domestic market involves the exchange of goods and services within a country (Salin, 2016). Transactions in the domestic market commonly involve the use of a common currency and fewer government restrictions. Contrary, Foreign exchange involves trade activities that facilitate the movement of goods and services between countries (Salin, 2016). The foreign exchange market involves using different currencies and enhanced government regulations through tariff and non-tariff barriers (Salin, 2016). Individual traders, companies, and banks are free to purchase different currencies in the foreign exchange market where prices vary with the forces of demand and supply (Coyle, 2001). Players in the foreign exchange market are mostly concerned about the changing value of different currencies and are keen to avoid losses (Coyle, 2001). Forward and spot markets are essential tools for managing currency risks.
Currency risk occurs due to changes in foreign exchange rates. In a spot market, the buyer purchases a currency at the prevailing exchange rate (Coyle, 2001). The price at the time of purchase is referred to as the spot price. Buyers may choose to enter into a spot contract if the delivery and payments are made within two days to avoid paying more because of changing foreign exchange rates (Salin, 2016). On the other hand, a forward market provides a foreign exchange rate pending transactions in the future. The contract to purchase a foreign currency specifies the amount of foreign currency for purchase, price, and future date (Coyle, 2001). Depending on the expected trends of future foreign exchange rates, a forward rate may be above or below the spot rate (Coyle, 2001). An open forward market provides for a range of dates within which the transaction may take place.
Delegate your assignment to our experts and they will do the rest.
In conclusion, unlike the foreign exchange market, the domestic market is free of currency risk. The spot and forward markets allow purchasers to protect their profits by managing the exchange rates.
References
Coyle, B. (2001). Foreign exchange markets. Taylor & Francis.
Salin, P. (2016). The International Monetary System and the Theory of Monetary Systems. Edward Elgar Publishing.
