This lesson reviews the main features of, and participants in, the foreign exchange market in order to understand how the market operates. In order to remain competitive, it is vital that companies can handle the currencies that financial markets dictate or that their commercial counterparties prefer .

8.1 The Foreign Exchange Market

The ACT syllabus identifies key features of the foreign exchange markets including market size and location, and the role of central banks in the foreign exchange market . The main market participants include:

• Market makers such as banks .

• Corporate treasuries .

• Central banks .

8.2 Spot and Forward Foreign Exchange

The ACT syllabus covers foreign exchange market dealing conventions, including spot and forward foreign exchange dealing . Spot transactions involve immediate delivery (typically T+2 settlement). Forward contracts are agreements to exchange currencies at a predetermined rate on a future date, used to lock in exchange rates and hedge future exposures.

8.3 Relationship Between Spot and Forward Rates

The final part of the unit examines the important relationship between spot and forward foreign exchange rates . The relationship between spot rates, interest rates, and forward rates is critical, as is understanding how to maximise the value of net assets and minimise foreign exchange risk . Forward rates are determined by spot rates and interest rate differentials between the two currencies.