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Types of Financial Instruments

There are many kinds of financial instruments in the foreign exchange market that are widely used today.

1. Futures - This is the type of currency that is defined as forward transactions that have standard sizes as well as dates of maturity. One example is 500,000 British pounds for next December at a rate previously agreed upon. The Futures have been standardized and usually they are traded on the exchange rates created for such purpose. The contract has an average length of 3 months roughly. The contracts usually include interest of any amount.

2. Forward Transaction - Another way to deal with the risk of the Foreign exchange is to deal in a transaction termed as forward transaction. In this type of transaction, one's money doesn't change the hands actually not until there is an agreed upon date in the future. The buyer and the seller agree on an exchange rate for a date anytime in the future, and the deal occurs on that particular date, and this is regardless of what the rates in the market would be then. Duration of trading could be carried out in a few days, months and even years.

3. Spot - This type of transaction is defined by its two-day delivery which when compared to the future type of contracts that have the duration of usually three months. The spot trade represents the "direct exchange" between two kinds of currencies. The spot has the shortest length of time. It involves money or cash rather than the contract. The interest is exclusive in the agreed transaction. The spot market is the source for the data of this study.

4. Swap - This is the most common kind of forward transaction. The currency swap consists of two parties exchanging currencies for a period of time. The two parties agree to reverse the trade at a certain later date. The Swap however is not considered as contracts and swaps are not traded through the exchange.

The difference between spot and Futures in Foreign Exchange

Before the description of trading in retail, it is very important that one comprehends the difference between the future and the spot kind of market. Futures are based on contracts generally, with the usual period of three months. On the other hand, the spot is only a two-day delivery of cash; furthermore the future markets were made to hedge out the risks and avoid speculation on the future of the market's conditions, while the spot was made to allow the actual delivery of cash.

A two-day date of delivery was also developed for the spot market to give those who are transporting the cash a lead time to receive the actual cash. In theory there is still a two-day date of delivery imposed after the foreign exchange transaction. This is however no longer used. Every day, at 5 in the afternoon Eastern Time, which is the predetermined ending time of the trade, the spot positions are being closed and reopened. This is undertaken to ensure the limitless timeline for the delivery.