Conversion operations are transactions of financial organizations that are associated with a currency exchange, or conversion. Often this happens due to registration of transactions for the purchase or sale of currency in any form (cash or cashless payments). Transactions can be carried out instantly (the term does not exceed 2 banking days) or after some period (more than two working banking days have passed since the transaction).
Terms and Definitions
Conversion operations are transactions of participants foreign exchange market. What is their essence? There is an exchange of a certain amount in the currency of one state for banknotes of another. In this transaction, the date and rate are determined.
The main market participants are currencies that are freely traded in the foreign exchange market. The main ones are:
- U.S. dollar;
- Euro zone money;
- Swiss franc
- pound sterling (England);
- Japanese yen.
Types of conversion operations:
- Instant deals.
- Current deals (or spot).
- Forward operations.
Operation Participants
Conducting conversion operations is available to such participants:
- Commercial banking structure. They account for the bulk of these transactions. The remaining participants hold accounts here and carry out all the necessary transactions. Conversion operations cover a large share of market demands in currency transactions, and also offer their services to other banks.
- Central bank. He must control the reserves in foreign currency, exercise foreign exchange interventions which affect the exchange rate. The Central Bank is in charge of controlling the level of deposit rates registered in the currency of its country.
- Currency exchange. Its functions: to form the exchange rate acceptable for the market, as well as carry out exchange operations for legal entities.
- State. In most cases, it is directly involved in controlling the exchange rate.
- Currency brokerage company. Here you can find participants in transactions for the sale of contracts. For conversion currency operations, these intermediaries charge a certain percentage.
- Foreign trade company. It is important for this organization to have a currency to carry out settlements with counterparties, so there is a steady demand on their part. At the same time, importers are always looking for how to purchase currency at the best rate, and it is important for exporters to sell the remaining amount.
- Individual. From their side there is a wide range of various operations with currency.
It is important to consider time
During the transaction, two dates are distinguished:
- The moment of the transaction.
- The moment of its execution. In other words, when the money was physically moved.
Banks, the most frequent currency exchange, call the value date the day when the money left the account. In the case of cashless transactions, this is the number when the money was actually exchanged for currency. Only business days are taken into account.
Depending on the value date, conversion operations are classified. This is a global practice.
Instant delivery
The vast majority of transactions are carried out with immediate delivery. Their feature: the date of execution of the transaction coincides with the day of its execution.
The seller delivers the currency on the maximum on the 2nd day after signing the contract (of course, the bank's working days are taken into account). These operations can be of several varieties:
- "Tod." The operations taking place today (the name came from the English. Today). The value date is equal to the date of the transaction.
- "Tom". Tomorrow's deal (from the English. Tomorrow). Value Date - the day following the day the transaction is executed.
Spot market
Current conversion operations are conducted on a spot basis. Here, the value date is equal to the second day from the date of transaction execution. World practice calls this spot-market.
The conditions for spot operations are quite comfortable for participants. During the current working day (or the next), you can slowly collect the full package of documents, generate payment documents for the operation.
The methodology for conducting these transactions consists in passing several steps:
- Preparatory. Here, the study of the current situation of the currency markets is carried out, the direction of movement of all currencies participating in exchange transactions is determined. Based on the results obtained, an average exchange rate is formed.
- Analytical. We study the dynamics of monetary rates. After the position of the bank is determined for each type of currency (increase or decrease). The amount of the operation is determined, the rate is fixed.
- The final. The operation goes through the accounts and is recorded in the documents.
Forward Transaction Market
These conversion operations are operations with a previously known and approved exchange rate. Transactions are executed in the current time (today), however, the value date is delayed for an indefinite period.
The objectives of such transactions are the creation of a certain airbag from foreign exchange rate hikes and the generation of income from speculation.
Forward operations are:
- Outright - a single copy operation. The value date here differs from the spot date. If any of the transaction currencies is quoted above a spot transaction, then it has a premium. If on the contrary, then she has a discount. The term rate, where discount or premium is taken into account, is called the "outright rate".
- Forward deals with option. These are operations where the delivery day is not fixed. Any participant has the opportunity to determine suitable conditions for fulfilling obligations. Another participant receives a bonus for this right, the amount of which depends on the duration of the option, on exchange differences at the time of signing the contract. The delivery date is not marked anywhere, only the period during which the terms of the contract are required to be fulfilled is prescribed. When the option is with the buyer, he will wait until the currency on the market becomes expensive, and then he will acquire it at a lower rate, which is specified in the contract. The seller, on the contrary, will wait until the currency value in the spot market decreases, then he will be able to sell it at a rate higher than that specified in the contract.
- Swap deals. This is one of the main methods of risk insurance, which consists in entering into opposite transactions (hedging). These are opposite deals, it is important to understand that one deal will be spot, the other - forward. A swap is a combination of cash trading and derivatives transactions.
Bank Risks
Conversion banking operations are not carried out at high risks. Let's consider them in more detail:
- Economic. Fluctuations in currencies affect the value of property, both for better and for worse.
- Translation risks. Associated with the difference in foreign currency accounting of bank property.
- Risks of transactions. They appear, since the cost of the operation to exchange the national currency for the currency of another country in the future cannot be determined. During volatility of courses, it is important to choose the optimal contract currency to protect against this risk.
Risk reduction
Banks, whose currency is exchanged regularly, have the chance to reduce risks in the implementation of exchange operations through the use of:
- Protective reservations. Conditions in the contract that imply a review of the terms of the contract during its execution.
- Gold reservations. The use of gold collateral currency.
- Currency clauses. The contract states that the amount will depend on fluctuations in the exchange rate.
Exchange operations with a competent approach and risk diversification are beneficial. However, to conduct them you need knowledge of the foreign exchange market, the features of the work not only of banks, but also of all market participants.
