The Language Of FX: Foreign Exchange Terms You Need To Know 2/3

Forward FX Contract

A simple forward FX contract purchases or sells foreign currency priced from today’s exchange rate for delivery on a specific date in the future. A “window forward” purchases or sells foreign currency priced from today’s exchange rate for delivery on or before a specific date in the future. Window forward transactions may involve several payments as long as the whole amount is delivered by the settlement date.

Future FX Contract

A standardised contract to buy or sell a specified amount of a given currency at a predetermined price on a set date in the future. Unlike FX forward contracts, futures are traded on recognised exchanges.

FX Option

A contract that grants the holder the right, but not the obligation, to buy or sell currency at a specific exchange rate for a limited period of time. For this right, the holder must pay the broker an amount known as the “premium”. The exchange rate is known as the “strike price”. An option that has not reached its strike price is said to be “out of the money”, while an option that has reached its strike price is “in the money” and would normally be exercised. If an option reaches its termination date without being exercised, it expires and the premium is lost. Options are a good way of limiting losses due to adverse exchange rate movements while benefiting from favourable movements.

FX Swap

An FX swap consists of simultaneous spot purchase or sale of one currency for another and forward purchase or sale of the same amount in the same currency pair in the opposite direction. It is equivalent to a term loan in one currency and a term deposit in the other.

Managed Float

A system of exchange rate management in which the currency is allowed to float versus other currencies, but the central bank influences the exchange rate by market purchases and sales of the currency. Most countries have managed rather than free-floating currencies. Managed float is also known as “dirty float”.

Non-deliverable Forward

A non-deliverable forward, or NDF, is a forward contract in which there is no exchange of currencies at maturity. Instead, at maturity the counterparties cash settle the difference between the contract rate and the prevailing spot rate on an agreed notional amount.