UNIVERSITY OF ECONOMICS AND LAW

FACULTY OF FINANCE AND BANKING

INTERNATIONAL FINANCE

ASSIGNMENT 2
Spot Market, Forward Market & Futures Market

Instructor: MSc. Hoàng Trung Nghĩa

Class: K16412
Group: 2
Name: Student code:
Lê Thị Châu Dung K164040446
Vũ Hoàng Giang K164040456
Nguyễn Thị Thúy Vi K164040583
Phạm Thị Thúy Vy K164040586
Trương Thị Huyền Trinh K164042202
Nguyễn Thị Thanh Thúy K164042193
Nguyễn Thị Trà K164042199
Nguyễn Đình Mai Vi K164042208
A. Spot Market
1. Definition
The spot market is where financial instruments, such as commodities, currencies and
securities, are traded for immediate delivery. In a spot market, settlement normally
happens in T+2 working days, i.e., delivery of cash and commodity must be done after
two working days of the trade date.
2. Types of Spot Market
The spot market which is also called the cash market is a financial market, in which the
financial commodities and instruments are transacted for instantaneous delivery. It
contrasts with a futures market in which distribution or delivery is owed at a later date. A
spot market can be:
1. Exchange- It is also called an organized market where the security or commodity is
traded on an exchange using and changing the current market price.
2. Over the counter (OTC) - In OTC, the trades are based on contracts which are done
openly between two parties, and not subject to the guidelines of an exchange. The
contract terms are approved between the parties and might be non-standard.
Spot transaction:
Step 1: Verbal agreement, US importer specifies:
A. Account to debit (his account)
B. Account to credit (exporter)
Step 2: Bank send importer contract note including:
- Amount of foreign currency
- Agreed exchange rate
- Confirm mation of Step 1
Step 3: Settlement
Correspondent bank in Hong Kong transfer HK $ from importers account to exporter’s.
3. Direct and Indirect Quote
The quotation of exchange rates for currencies normally reflect the ask prices for large
transactions. Since exchange rates change throughout the day, the exchange rates quoted
in a newsaper reflect only one specific point in time during the day. Quotations that
represent the value of a foreign currency in dollars (number of dollars per currency) are
referred to as direct quotations. Conversely, quotations that represent the number of unit
of a foreign currency per dollar are referred to as indirect quotations. The indirect
quotation is reciprocal of the corresponding direct quotation.
 The quote is direct when the price of one unit of foregin currency is expressed in
terms of domestic currency.
 The quote is indirect when the price of one unit of domestic currency is expressed
in terms of foreign currency.
Example:
The spot rate of the euro is quoted this morning at $1.031. This is a direct quotation, as it
represents the value of the foregin currency in dollars. The indirect quotation of euro is
the reciprocal of the direct quotation:
Indirect quotation = 1/Direct quotation
= 1/$1.031
= 0.97, which means 0.97 eurors = $1
If you initially received the indirect quotation, you can take the reciprocal of it to obtain
the direct quote. Since the direct quotation for the euro is $0.97, the direct quotation is:
Direct quotation = 1/ Indirect quotation
= 1/0.97
= $1.031
4. Bid/ ask spead
Bid-ask spread (also called bid-offer spread) is the excess of the price at which a financial
market participant is willing to sell a financial instrument (the ask or the offer) over the
price at which he is willing to buy it (the bid).
Bid-ask spread is the mechanism by which dealers in the quote driven markets are
compensated.
Market bid-ask spread equals the excess of the best ask (the lowest ask) over the best bid
(the highest bid. Though every participant in a quote-driven market has his own bid and
ask prices, the market bid-ask spread is different from individual bid-ask spreads.
Bid-ask spread depends on market liquidity and volatility of the relevant financial
instrument (i.e. stock, currency, bonds, etc.)
A bid is an offer made by an invester, trader, or dealer in an effort to buy a security,
commodity, or currency. A bid stipulates the price the potential buyer is willing to pay, as
well as the quantity he or she will purchase, for that proposed price.
The ask is the price a seller is willing to accept for a security, which is often referred to as
the offer price. Along with the price, the ask quote might also stipulate the amount of the
security available to be sold at the stated price.
Example:
Citi bank quote a bid for yen of $0.007 and an ask price of $0.0074. In this case, the
nominal bid/ask spread is $0.0074 - $0.007, or just four-hundredths of a penny. Yet, the
bid/ask spread in percentage term is actually sightly higher for the yen in this example
than for the pound in the previous example. To prove this, consider a traveler who sells
$1,000 for yen at the bank’s ask price of $0.0074. The treveler receives about ¥135,135 (
computed as $1,000/$0.0074). If the traveler cancles the trip and converts the yen back to
dollars, then, assuming no changes bid/ask quotations, the bank will buy these yen back
at the bank’s bid price of $0.007 for a total of about $946 ( computed by ¥135,135 *
$0.007), which is $54 ( or 5.4 percent) less than what the traveler started with.
A common way to compute the bid/ask spread in percentage terms follows:
𝐴𝑠𝑘 𝑟𝑎𝑡𝑒 −𝐵𝑖𝑑 𝑟𝑎𝑡𝑒
Bid/ask spread =
𝐴𝑠𝑘 𝑟𝑎𝑡𝑒
Using this formula, the bid/ask spread are computed for Japanese yen.
Currency Bid rate Ask rate 𝐴𝑠𝑘 𝑟𝑎𝑡𝑒 − 𝐵𝑖𝑑 𝑟𝑎𝑡𝑒 = Bid/ask
𝐴𝑠𝑘 𝑟𝑎𝑡𝑒 percentage spread
Japanese yen $0.0070 $0.0074 $ 0.0074 − $ 0.0070 = 0.054 or 5.4%
$0.0070
B. Forward Market
1. Definition
A forward contract is an agreement between two parties to buy or sell an asset (which can
be of any kind) at a pre-agreed future point in time at a specified price.
Ex:

+ Scenario 1: After 3 months the spot rate goes up to Rs.42, customer will have a
gain of Rs.10.
+ Scenario 2: After 3 months if the spot rate drops to Rs.38, customer will incur a
loss of Rs.10.
+ Scenario 3: After 3 months if the price is stagnant at Rs.40, neither of them
incurs any profit or loss.
2. Structure & Purpose
- Customized to customer needs
- Usually no initial payment required
- Usually used for hedging
3. Transaction method
Negotiated directly by the buyer and seller.
4. Market regulation
Not regulated
5. Institutional guarantee
The contracting parties
6. Risk
High counterparty risk. As Forward Contracts do not have any clearing house or other
institutional agents in the contract, exposure to counterparty risk is substantial. Moreover,
forward contracts are not Marked to Market on daily basis; instead they are agreed to be
settled at a future date at an agreed price; this leads to the high volume of risk.
7. Guarantees
No guarantee of settlement until the date of maturity only the forward price, based on the
spot price of the underlying asset is paid.
 8. Contract Maturity
Forward contracts generally mature by delivering the commodity.
9. Method of pre-termination
Opposite contract with same or different counterparty. Counterparty risk remains while
terminating with different counterparty.
10. Example
i. Video
https://www.youtube.com/watch?v=H9UEZdAnnt8
ii.
For example, if the market price of the underlying asset is higher than the price agreed in
the forward contract, the seller loses. The contract may be fulfilled either via delivery of
the underlying asset or a cash settlement for an amount equal to the difference between
the market price and the price set in the contract i.e., the difference between the forward
rate specified in the contract and the market rate on the date of maturity. For an intro to
forward contracts
iii.
Charlotte Co. expects to receive 100,000 euros from exporting products to a Dutch
firm at the end of each of the next 3 months. The spot rate of the euro is $1.10. The
forward rate of the euro for each of the next 3 months is also $1.10. Charlotte Co. expects
that the euro will depreciate to $1.02 in 3 months.
If Charlotte Co. does not use a forward contract, it will convert the euros received into
dollars at the spot rate that exists in 3 months. A comparison of the expected dollar cash
flows that will occur in 3 months follows.

Thus Charlotte expects that its dollar cash inflows would be $8,000 higher as a result of
hedging with a forward contract and decides to negotiate a forward contract to sell
100,000 euros forward. If Charlotte Co. were an investor instead of an exporter, and
expected to receive euros in the future, it could have used a forward contract in the same
manner.

C. Futures Market
1. Definition
A futures contract is a standardized contract, traded on a futures exchange, to buy or sell
a certain underlying instrument at a certain date in the future, at a specified price.
A futures contract is a financial contract giving the buyer an obligation to purchase an
asset (and the seller an obligation to sell an asset) at a set price at a future point in time.
The assets often underlying futures contracts include commodities, stocks, and bonds.
Grain, precious metals, electricity, oil, beef, orange juice, and natural gas are traditional
examples of commodities, but foreign currencies, emissions credits, bandwidth and
certain financial instruments are also part of today's commodity markets.
There are two kinds of participants in futures markets: hedgers and speculators. Hedgers
do not usually seek a profit by trading commodities futures but rather seek to stabilize the
revenues or costs of their business operations. Speculators are usually not interested in
taking possession of the underlying assets. They essentially place bets on the future prices
of certain commodities. Speculators are often blamed for big price swings in the futures
markets, but they also provide a lot of liquidity to the futures markets.
An oil producer needs to sell their oil. They may use futures contracts do it. This way
they can lock in a price they will sell at, and then deliver the oil to the buyer when the
futures contract expires. Similarly, a manufacturing company may need oil for making
widgets. Since they like to plan ahead and always have oil coming in each month, they
too may use futures contracts. This way they know in advance the price they will pay for
oil (the futures contract price) and they know they will be taking delivery of the oil once
the contract expires.
Futures are available on many different types of assets. There are futures contracts on
stock exchange indexes, commodities, and currencies.
Video bổ sung: ví dụ
https://www.investopedia.com/terms/f/futurescontract.asp
2. Structure & Purpose
- Standardized
- Initial margin payment required
- Usually used for speculation
Purpose:
The first is as a financial vehicle. As discussed above, traders use futures contracts to
speculate on the future value of assets. They build investments around predicted swings
in value, and their goal is to make money off accurate speculation.
The second purpose of the futures market, and the one for which it was invented, is price
stabilization. Businesses which rely on either buying or producing a long-term supply of
raw goods use futures contracts so that they can set their prices in advance. This gives
them certainty and insulates them from having to adapt to random fluctuations in asset
prices. This is called hedging, and it is typically used as a loss-prevention technique
rather than as a profit center.
https://www.youtube.com/watch?v=3bPRN_GhHiY
3. Transaction method
Quoted and traded on the Exchange

4. Market regulation
Government regulated market (the Commodity Futures Trading Commission or CFTC is
the governing body).
5. Institutional guarantee
Clearing House:
A central counterparty clearing house (CCP) is an organization that exists in various
European countries to help facilitate trading done in European derivatives and equities
markets. These clearing houses are often operated by the major banks in the country to
provide efficiency and stability to the financial markets in which they operate. CCPs bear
most of the credit risk of buyers and sellers when clearing and settling market
transactions.
Functions of a CCP
A CCP hides traders’ identities from each other as a means of protecting their privacy.
The entity also protects trading firms against default from buyers and sellers who are
matched by an electronic order book and whose creditworthiness is unknown. In
addition, a CCP reduces the number of transactions being settled, which helps operations
run more smoothly and reduces the value of obligations being settled, which helps money
move more efficiently among traders.
Trung tâm thanh toán bù trừ

A clearing house is a financial institution formed to facilitate the exchange of payments,

securities, or derivatives transactions. The clearing house stands between two clearing
firms (also known as member firms or participants). Its purpose is to reduce the risk of a
member firm failing to honor its trade settlement obligations.
6. Risk
Low counterparty risk
7. Guarantees

Both parties must deposit an initial guarantee (margin). The value of the operation is
marked to market rates with daily settlement of profits and losses.

8. Contract Maturity

Forward contracts have no cash flows except at maturity. Futures contracts are marked to
market daily. And, for a forward contract, the entire effect of changing prices is taken
into account at maturity, whereas for a futures contract, the effect of changing prices is
taken into account on an ongoing basis. So,
Future contracts may not necessarily mature by delivery of commodity.

9. Method of pre-termination

Opposite contract on the exchange.