A currency future(s) is a contract that details the price at which currency could be bought or sold and sets a specific date for the exchange. A currency future is known as an FX future or a foreign exchange future.
This type of foreign exchange derivative sets the price at which one currency will be exchanged for another at a specified date in the future. Currency futures are one of the instruments used to hedge against currency risk.
They are highly regulated, and any counterparty still holding the contract at the expiration date is legally bound to take delivery of the currency on the given date and at the given price.
What is the difference between spot and futures prices?
A futures price differs from a spot price as it is not based on current market value, but a potential market price in the future.
If traders have open positions on a spot currency rate, they may use a currency futures contract to hedge.
What is the difference between currency futures and currency forwards?
Both currency futures and currency forward contracts are financial derivatives that allow people to buy and sell currency pairs at a specific time and a given price.
Though they are similar, they operate with a few key differences:
|Currency futures are…
|Currency forwards are…
|Traded on an exchange
|Highly standardized transactions with legally binding terms and conditions
|Privately negotiated and specific to individual traders needs
The main difference between a currency future and a currency forward is that futures are traded through a central market, whereas forwards are over-the-counter contracts (private agreements between two counterparties).
The risk of default on futures contracts is virtually zero as they always involve a central clearinghouse, whereas forwards always carry the risk of counterparty default. Some providers require client collateral to cover this risk.
A forward contract sets a rate with an expiry date. A futures contract establishes daily market (mark-to-market) rates, and the daily price differences are settled or included daily in the contract until it ends.
A futures contract is normally a speculative product for investors, while forwards are more commonly used by companies seeking to protect themselves against currency volatility.
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