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- Key denies Auckland housing crisis 85
- Bernard's Top 10 at 10 71
- What happened Thursday 54
- Bernard's Top 10 at 10 44
- Bernard's Top 10 36
- The accidental property investors 35
- English concerned about Auckland rents 34
- Key supports GST on online sales 32
- RBNZ sees flat rates until 2017 31
- Govt reports first surplus in 6 years 29
- 90 seconds at 9 am: Oil worries 4
- Nervous investors pile into USD
- Sharp swings in USD
- What happened Friday
- What happened Thursday
- Bernard's Top 10 36
- 90 seconds at 9 am: 'Rigged remuneration' 6
- 90 seconds at 9 am: ECB QE arrives 3
- Bond yields and carry trade drive the NZD
- English sanguine about record high NZ$ 6
For most business transactions, you know well in advance what you will need to buy or sell. The Forward market exists so that you can do a deal now at a known price for delivery at some time (usually month periods) in the future.
The forward foreign exchange agreement you will make with an institution is conceptually straightforward. It will be based on today’s spot rate, plus-or-minus the interest rate differential between the two currencies for the period forward.
If the currency you are buying has lower interest rates than the one you are selling, the forward rate will give you less of the currency than the spot rate – and vice versa.
Another way to understand forwards is to realise that the bank is not taking any risk. They close out their positions at least once each day, often more often. They do that by effectively buying or selling the currency today and investing the foreign funds for the time period at that interest rate. On the forward date they (or you) will deliver the agreed amount (original spot plus-or-minus the difference between the interest earned/cost of each currency). It’s a spot transaction plus the holding costs to the delivery date.
This is an effective way to lock in a foreign currency transaction for a future date at a known cost, using the bank’s wholesale access to interest rates in each currency. (It’s not your access to the foreign money market rates; it’s the bank’s access that makes this work.)