A conversion operation is a transaction conducted by participants in the foreign exchange market to exchange the currency of one state for the monetary unit of another. At the same time, their volumes are agreed in advance, as well as the rate with making calculations after a certain time. If we consider the concept from a legal point of view, we can conclude that the conversion operation is a purchase and sale transaction of a currency. In order to denote it, the stable English concept of Forex or FX is used, which is an abbreviation for the expression Foreign Exchange Operations - "currency exchange operations".
Conversion operations differ from traditional lending and deposit operations in that they are carried out at a certain exact moment in time. Transactions of the second type have different urgency and time duration.
Types of conversion operations
These operations can be divided into two main types:
- current or spot transactions;
- urgent or forward transactions.
Spot operations (spot) occupy the largest volume in the market. International practice provides that the date of their implementation is the second business day after. These conditions are suitable for the participants in the transaction, since during the provided time it is possible to complete the processing of payment documents and the processing of existing documentation. The place that is defined for the exchange of currencies at current quotes is the spot market .
Forward conversion operations (forward) include:
- forwards
- futures
- options (options) ;
- swaps.
These transactions can also be found under the name "derivatives" (derivatives). They were specially created for real business. This is due to the fact that they allow in the future to reduce changes in quotations in the international currency market. For those who wish to make money using the Internet at Forex, these financial instruments are practically irrelevant. Moreover, they should be considered for understanding the concept of conversion operations and their types.
Spot market and its participants
The spot market is a market for the urgent delivery of currency. The main participants are banks, which exchange currency on the spot market with partners:
- with client companies directly;
- with commercial banks in the interbank market;
- with banks and customers through brokers;
- with central banks of states.
The spot market can serve individual requests and speculative operations of companies and financial institutions.
Spot Market Rules
The rules of this market are not fixed in international conventions, but all participants in transactions adhere to them without fail. These include:
- Payments must be made no later than two business banking days, moreover, for the amount of the agreed currency without additionally setting the interest rate;
- most often, transactions are carried out on the basis of computer-based trading, which provides for confirmation on the next business day using electronic notifications;
- the course must be followed without fail.
The main tool of the spot market is called electronic transfer, carried out through the channels of the SWIFT system (SWIFT).
Objectives of spot conversion operations
This type of transaction accounts for about 40 percent of FOREX trading volume. Their main goals are:
• execution of conversion type orders of clients of a financial institution;
• liquidity support, for which banks exchange currency from one to another using their own funds;
• conclusion of speculative conversion transactions;
• the exclusion of the possible presence of uncovered account balances, for which the currency position is regulated ;
• reduction of surpluses in one currency, as well as reimbursement of the need for another.
Forward contracts
A forward conversion transaction is a currency exchange transaction at a previously agreed rate. The value date in this case is postponed for a certain period, which is agreed upon by both parties to the transaction.
Forward contracts are most beneficial if a domestic company has plans to purchase goods abroad for US dollars. At the same time, it may not have the required amount of funds for operations at the time of conclusion of the contract, but expects their receipt. In such a situation, it makes sense to use a forward agreement to purchase the necessary amount of currency with a suitable value date at quotations favorable to the company. This option is acceptable while waiting for a change in the course in an unfavorable direction.
Forward contracts can be beneficial and minimize risks, but in some cases can cause lost profits. Using the example of a domestic company, this means that the currency will not become more expensive, but rather cheaper. Thus, the company could pay for goods a smaller amount in rubles.
Futures and options
A futures conversion transaction is a transaction that has fixed amounts of currency and standard terms of value. Thus, such contracts can be sold as securities. The futures market is intended for trading them. The average duration of circulation of these conversion operations can be called three months.
Options are similar to futures, but the obligations of one of the parties are significantly weakened. You can refuse to conduct a transaction at any time if necessary. At the same time, these contracts are traded on a separately designated options market.
Swaps and their features
Swaps are conversion currency transactions that involve the conclusion of a transaction aimed at buying and selling a set amount of currency. The obligation in this case is to complete the reverse transaction after a certain time. Quite often they represent the conversion operations of banks and organizations. The generally accepted standards do not apply to them; therefore, there is no separate market for them. Among all financial instruments, they are of the least importance.
Conversion deals
Conducting conversion operations requires some preparation, especially minimization of risks. A short delivery time of foreign currency does not reduce the risk that counterparties bear on this transaction. This is due to the fact that the course may change in a short time.
The technique of concluding transactions consists of several stages. First of all, the analysis of the state of foreign exchange markets is carried out, as well as the trends in the movement of the rates of specific currencies are determined. In addition, at the preparatory stage, it is necessary to study the causes of their change. Based on the information received, dealers can take into account the currency position that they have. Thus, the rate of the national currency in relation to foreign currency is determined using computer technology.
Bank conversion operations require limiting potential risk. For this reason, operations should be carried out with reliable partners. The analysis will allow us to develop the direction of foreign exchange transactions. Thus, a short or long position in a certain currency is provided, which is used during the transaction.
In large banks, conversion operations on customer accounts are carried out thanks to special groups of economists and analysts. Dealers take into account their information and independently choose the direction of currency transactions. Smaller banks do not have these specialists and their functions are performed by dealers themselves.
When making conversion currency transactions, it is necessary to have a sufficient amount of knowledge and practical skills, so it is worth studying in detail each of their types.