The Role of Banks in Forward Exchange 2

On the other hand, if the demand for forward exchange exceeds its supply, the forward rates will be quoted at a premium over the spot rate - i.e., forward rate will be higher than the spot rate. The demand for forward exchange arises, mainly, from imports, outflow of capital, arbitrage operations, and bullish speculation.

An importer of foreign goods having to make payment, after a certain period of time, may contract to purchase foreign exchange in advance, to avoid the risk of changes in exchange rates. Arbitragers move funds from one centre to another, to earn profits out of the interest differential that may exist between the two centers.

An arbitrager who transfers funds abroad takes advantage of a comparatively higher rate of interest abroad, contracts at the same time to sell forward exchange to cover them against exchange risks.

Speculators intentionally take an open, or uncovered, position, expecting to gain from future changes in the exchange rate. If the speculators expect a rise in the exchange rate, they will have an incentive to contract for the purchase of forward exchange. Similarly, the supply of forward exchange comes, mainly, from exporters of merchandise, exporters of capital, arbitragers, and speculators.