Methods and Characteristics of Forward Foreign Exchange Trading

Forward foreign exchange trading, also known as forward exchange trading, is a type of foreign exchange transaction. So, what are the main methods and characteristics of forward foreign exchange trading?

1. Methods of Forward Foreign Exchange Trading

1. Direct Trading
   This involves trading directly in the forward foreign exchange market without corresponding transactions in other markets. Banks typically quote forward exchange rates not in absolute terms but as a differential (in basis points) between the forward rate and the spot rate. The forward rate may be better or worse than the spot rate.

2. Option-Based Trading
   Companies often cannot predict the exact date of their foreign exchange income in advance. Therefore, they can engage in option-based forward trading with banks, which grants them the right (but not the obligation) to execute the forward contract within a specified period (e.g., 5-6 months) after the trade date.

2. Characteristics of Forward Foreign Exchange Trading

(1) After signing the contract, neither party needs to immediately deliver the foreign or domestic currency; settlement occurs at a future agreed date.
(2) Large transaction volumes.
(3) The primary purpose is hedging to mitigate exchange rate fluctuation risks.
(4) Contracts between banks and clients require guarantees from foreign exchange brokers.

Additionally, clients must deposit a margin or collateral. If exchange rate fluctuations are minor, the bank can offset losses with the margin. If losses exceed the margin, the client must top up the margin; otherwise, the contract becomes void. The margin is treated as a deposit and accrues interest.