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Chapter 11: Problem 2

What is meant by the forward market? How does it differ from the spot market?

Short Answer

Expert verified
Forward Market is where assets are bought or sold for delivery at a future date, unlike Spot Market where transactions are settled immediately. The main difference is the timing of payment and delivery.

Step by step solution

01

Definition of Forward Market

A Forward Market is a contractually agreed market where buyers and sellers buy or sell assets at a specified price for delivery on a specified future date. The contracts are privately negotiated and are not standardized.
02

Definition of Spot Market

A Spot Market, on the other hand, is a market where financial instruments, such as commodities, currencies and securities, are traded for immediate delivery. Delivery of the asset purchased occurs on the 'spot', and payment is made instantly. It is also called 'cash market' or 'physical market'.
03

Contrasting Forward and Spot Markets

While both markets involve buying and selling of assets, the key difference lies in the timing of the payment and delivery. In a Spot Market, transactions are settled 'on the spot'. However, in a Forward Market, the buyer and the seller agree upon a future date for delivery and payment. Therefore, in Forward Market, the risk of price fluctuation exists, but it is absent in Spot Market.

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Most popular questions from this chapter

Who are the participants in the forward exchange market? What advantages does this market afford these participants?

If the exchange rate changes from \(\$ 1.70=£ 1\) to \(\$ 1.68=£ 1\), what does this mean for the dollar? For the pound? What if the exchange rate changes from \(\$ 1.70=£ 1\) to \(\$ 1.72=£ 1\) ?

Suppose \(\$ 1.69=£ 1\) in New York and \(\$ 1.71=£ 1\) in London. How can foreign exchange arbitragers profit from these exchange rates? Explain how foreign exchange arbitrage results in the same dollar/ pound exchange rate in New York and London.

The supply and demand for foreign exchange are considered to be derived schedules. Explain.

What is the strategy of speculating in the forward market? In what other ways can one speculate on exchange rate changes?
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