Key reasons for forward exchange transactions

Actual exchange market participants are banks, companies, individuals, governments, and other financial institutions. However, these participants are called arbitrageurs, traders, hedgers, or speculators, depending on the purpose of their participation in the exchange market. Arbitrageurs seek to earn riskless profits by taking advantage of differences in interest rates among countries. Traders use forward contracts to eliminate possible exchange losses on export or import orders denominated in foreign currencies. Hedgers, mostly MNCs, engage in forward contracts to protect the home-currency value of foreign currency denominated assets and liabilities. Speculators deliberately expose themselves to exchange risk by engaging in forward contracts in order to make a profit from exchange rate fluctuations.

Individuals and corporations buy and sell forward currencies to provide protection against future changes in exchange rates. So long as we do not have a single world currency, some degree of exchange risk exists in any system. We cannot eliminate some possibility of foreign-exchange losses in either the fixed exchange rate system or the flexible exchange rate system.

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