Unlike all other exchanges where one of the equivalents is cash or currency, the Foreign Exchange Markets oversee the trading of two or more currencies. The exchange market determines the foreign exchange rate between two currencies based on the supply and demand of currencies. The markets indulge in trading massive volumes and functions primarily as an over-the-counter (OTC) market. When two parties enter into a physical contract without an exchange the transaction is said to be an OTC. Exchange rates are determined by financial institutions by using an ‘interbank market’ rate.
Financial Instruments, Asset Classes and Investment
To make sure investors choose the right instruments for their needs, those instruments are classified into different asset classes based on their characteristics, behavior, or the regulations that affect them.
3. Classification of Financial Instruments C
Commodities fall into another group of assets that can be traded. Both virtual and physical marketplace for commodities exist and traders can buy or sell through various commodity exchanges. Many different types of commodities are traded almost daily ranging from crude oil, gold, silver, corn, coffee, sugar to milk, cattle, pork, etc.
8775 The definition is wide and includes cash, deposits in other entities, trade receivables, loans to other entities. investments in debt instruments, investments in shares and other equity instruments. 8776
Since a derivative, as the name suggests, functions on the underlying commodity, its price is determined based on the price of the commodity. Any fluctuation in the price or performance of the commodity will directly impact the derivative's value.
This asset class has a shorter maturity period (less than a year), thus exhibiting very high liquidity. T-bills, CDs, Commercial Papers (CPs), are common examples of money market instruments.
Cash instruments are instruments that the markets value directly. Securities, which are readily transferable, for example, are cash instruments. Deposits and loans, where both lender and borrower must agree on a transfer, are also cash instruments.
For example, company A and company B agree on a swap where company A pays company B a fixed interest payment of 9% every year on a notional amount of $65 million. Company B agrees to pay company A a variable interest payment of 7% plus the fed's rate per year.
To understand the derivative market, let's analyze a simple contract between a farmer and a consumer. If both the parties enter into a future contract (whose expiry is maybe 6 months down the line) where the farmer promises to deliver 6555 quintals of wheat to the consumer at $65 per quintal, there are three possible outcomes: