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Foreign Exchange Transaction: Spot, Forward & Swap

Here are the basic types of foreign exchange transactions.

Which one of these do you think you need to pay the most attention to (which poses the greatest risk)?

a) Spot

b) Forward

c) Swap

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Please see response below. I also attached an informative chapter on managing foreign exchange risk.

RESPONSE:

1. Here are the basic types of foreign exchange transactions. Which one of these do you think you need to pay the most attention to (which poses the greatest risk)? (a) Spot (b) Forward (c) Swap

Each type of foreign exchange transaction needs your attention, and as for risk, each type of foreign exchange is used to reduce risk associated with sending and receiving international payments. The risk of loss stemming from exposure to adverse foreign exchange rate movements is reduced through the following types of transactions. (4) Specifically, foreign exchange transactions are used for sending and receiving international payments. In general, dealing in foreign currency (e.g., spot, forward, forward windows contracts, and swap) can save you time and money, reduce risk, and help you gain a competitive advantage.

· Save time. When you send a wire in foreign currency, the recipient does not have to wait for the overseas bank to accept it and convert it to local currency. Wires sent in foreign currency move directly to the foreign beneficiary and are subject to less delay than US denominated wires sent through intermediary banks. In many countries, Wells Fargo maintains accounts that can be used to receive incoming wires and accelerate collection times.
· Save money. When you send international wires in foreign currency, you pay lower fees than for US dollar international wires. You may also pay lower international bank fees.
· Reduce risk. By sending a wire in foreign currency you can lock in the exchange rate, secure your order, and know the full cost of the transaction before the wire is sent.
· Gain competitive advantage. You may be able to negotiate a better price with your overseas business partner. By receiving a wire in local currency, the beneficiary will avoid assuming the risks of currency rate fluctuations and the costs of foreign exchange. (1)

So in answer to your question about which type provides the most risk, it depends. For example, different types of foreign exchange transactions are used for different purposes (as seen below), but all save time, money, reduce risk and gain competitive advantage in the given situation, and like other business transactions need your full attention. You also need to understand and be knowledgeable in what you are doing. Risk is not risk, however, if it is anticipated. In most currencies, for example, there are futures or forward exchange contracts whose prices give firms an indication of where the market expects currencies to go. And these contracts offer the ability to lock in the anticipated change. (6)

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Solution Summary

Based on the basic types of foreign exchange transactions, this solution discusses which one of these poses the greatest risk and needs to be paid attention to: spot, forward and swap. It also includes an informative chapter on managing foreign exchange risk. References are included.

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