Section I: Term Transactions. General Characteristics and Classification There has always been a desire to avoid the risk associated with trade and economic activity across currency boundaries. With the improvements in financial techniques in the latter half of the nineteenth century in Europe, genuine Term markets - markets in which currencies were traded for future delivery - emerged. Since that time, official or unofficial types of these transactions have taken place whenever exchange rates fluctuated or were subject to significant uncertainty. Nowadays, the most important financial markets in the world are provided with “future” and “options” products. These markets are also called Derivative (or Synthetic) markets, as the contracts negotiated posses fundamental values and allow such operations like: speculations, hedging or arbitrage, as well as covering the existing hazards. Derivatives can play an active role in management of financial risk. If used prudently, they can both: reduce financial risk and achieve cash flow and budget certainty. There are known 2 types of Derivative markets:  Organized Markets-structured upon a ”compensation house” – clea-ring house - ensuring the compensation in transactions. The most de-veloped markets of this kind are: CBOT (Chicago Board of Trade); LIFE (London International Financial Futures Exchange); MATIF (Marche a Ferme Internationale de France); EOE (European Options Exchange);  OTC Markets (also called “Over the Counter” or “de gre a gre”) - much more subtle structures that - many times - put the operators face-to-face. A Derivative Transaction represents a financial contract that derives its value from an underlying asset, commodity, liability or index. A Term Transaction (fr.” a reglement mensuel)- is the transaction that is being settled on the Stock Exchange at a certain moment of time and is to be executed at a fixed date (liquidation date) one of the next few months, the terms and conditions being stipulated subsequently in the contract. Under a forward contract, the two counter-parties (buyers and sellers) agree to exchange a specific quantity of an underlying item (real or financial) at an agreed contract price—strike price –on a specified date (starting up with 48 hours from the concluding of the contract). The contract can also be regarded as an unconditional financial contract that represents an obligation for settlement on a specified date. The transaction takes place immediately, but the transfer of currency is being made after a certain period of time (stipulated in the contract). For the execution of the transaction, the client either gives an order (for selling or buying) to the broker, or the Stock Exchange at a well-determi-ned exchange rate, relying on the given order process looking for the counter-parties. The sellers, in this case, are those persons who engage themselves to deliver assets (commodities, securities, foreign currency) at the contract’s price (they open a short position by selling the underlying item). The buyers (opening a long position) respectively, are the persons engaged to purchase the assets contracted. The price of the forward contract represents the price at which the contract shall be executed in the future. It remains unchangeable during all the period of the forward contract being determined in the moment of contract negotiations, according to both parties’ expectations. At the inception of the contract, risk exposures of equal market value are exchanged.Both parties are potential debtors, but a debtor/creditor relationship can be established only after the contract goes into effect. Thus, at the inception, the contract has zero value.However, during the life of a forward contract, the market value of each party’s risk exposure may differ from the zero market values at the inception of the contract as the price of the underlying item changes. When this occurs, an asset (creditor) position is created for one party and a liability (debtor) position – for the other.The debtor/creditor relation-ship may change both in magnitude and direction over the life of the for-ward contract. It is worth mentioning that in order to ensure themselves from possible accumulated risks, financial intermediars require the clients to set up so-called „coverage deposits”i.e.”a margin”( containing 20-50% out of transaction value). The client must preset the „coverage”or the guarantee through the transfer of a certain sum of money or securities as a margin which, on the other hand represents the broker’s warranty during transaction. If rate of exchange expectations do not prove true, investors will gain losses through the means of the forward contract (the byuer looses if exchange rate goes down; the seller-if it goes up).Anyways, the loss of one counter-party involves financial gains of the other one. In order to diminuesh losses, forward transactions are often acompanied by other term transactions, the opposite of the initial ones (for example: the selling of the asset contracted for the initial byuer) .This way at the liquidation date compensation in gains and losses is attested. But the main purpose of the parralel opposite transactions is gaining profit out of Speculations.Forward markets are one of the primary channels for speculators to attack a fixed exchange rate regime as well as for the Central Bank to defend the rate of exchange. To limit the capital losses resulting from market intervention, intervention should be switched to the spot market and accompanied by interest rate increases once net nonborrowed reserves have been commited in the forward market. Speculative transactions represent the transactions whos’aim is gaining profit out of the difference of prices of the asset between the moment of settlement and the liquidation of the contract.Speculators are any agents who believe that the current exchange rate will collapse in the near future and so take positions against the currency.Contractors opening a long posi-tion expects a further price increase; contractors opening a short position – a price decrease. Contractors’expectations for further price increase or decrease might not succeed within forecasted period, expectations being prolongated for the future. Prolongation represent a forward street transaction which includes:  Report – which represents the selling of securities to an interme-diar owner for a defined period of time at a lower price than the repayment one at the maturity;  Deport – the reverse transaction of the privious one, used by traders when expecting the decrease of price; Forward markets allow, besides speculations, several other operations like:  Arbitraje - the main purpose of which is gaining profit out of the difference between the prices of securities transacted simulta-neously on two dif ferent markets;  Hedging – which represents a protection against or limiting losses on an existing stock position by establishing an opposite one for the same or an equivalent security,this way participants ensuring themselves agains the hazards of price fluctuation. Because forward contracts do not generraly require payments before maturity (except where a commission is due to the outset), market partici-pants do not experience any initial loss in liquidity. As a rule, the Forward Contract has the following peculiarities: 1. It is closed throughout direct negotiations between the counter-parties, i.e. it does not represent a typical stock exchange contract; It is not standardized, the parts agreeing on the quantity and quality of goods, price (as mentioned before), methods of payments and terms of delivery; 2. The contract has a fixed value: at the liquidation date, the buyer pays a pre-established price, whose’ value does not change (along with mar-ket variations); 3. The period between the moment of closing the contract and its execu-tion is standardized and varies between 1 week and 1-2 years (depen-ding on the country). Forward transactions are used for the following purposes:  To avoid hazards related to the fluctuations of exchange rates;  To modify the structure of currency funds for a certain period of time;  To obtain a profit from speculative operations as a result of ex-change rate evolution; If taking into consideration the negative and positive effects of these transactions, forward markets generally present more advantages than di-sadvantages: 1. Term transactions allow speculations, lending themselves towards gaining profit out of these operations; 2. Allowing arrangements of parallel opposite transactions leads towards several positive effects (diminishing or totally reducing losses); 3. The physical presence of titles is not obligatory during arrangements of transactions, the investor has to open just a minimum coverage de-posits (margin); 4. They lead to the increase in efficiency and reduction of markups on imported goods that should result from lower exposure to exchange rate risk; 5. Improvements in investment climate; 6. Forward markets reduce the needs of traders for working balances in foreign currency, thus improving overall availability of foreign exchange; 7. They encourage importers to gain access to foreign sources of finan-cing, thus providing further support to the balance of payments. Nevertheless, forward transaction is a firm transaction i.e. contractors are not insured against the non-execution of the contract (the seller can refuse execution of the contract, paying instead some penalties; then selling the securities on the market. In this case the profit obtained will be considerably higher than that of contract execution). Forward markets generally include three types of subordinated markets:  Future market;  Options market;  Swap market; 1.1. Futures Transactions A Future market represent a prototype of forward market including additional featured elements like concluding of only standardized contracts at the Stock Exchange and only according to its regulation as well as setting of coverage deposits (minimum margin required). Future markets made its’ appearance in Japan somewhere during the XVIII- th century, being connected with rice trading but, had taken their modern shape in the latest half of the past century (1848 – Constitution of CBT (Chicago Board of Trade)). Subsequently these contracts have widened up from goods to currency, financial instruments and other assets. A Future Contract represents an agreement between two contra-parties on future delivery of the subject of the contract, closed at Stock Exchange in accordance with its regulation. It can be regarded as well as a standardized contract establishing a binding obligation to buy or sell a particular currency at a designated exchange rate on a specific future date (compared with after a specific interval in the case of forward contracts). Futures contracts are forward contracts traded on organized exchanges which are settled by the payment of cash or the provision of some other financial instrument rather than the actual delivery of the underlying item and therefore are valued and traded separately from the underlying item. The future market is organized in such a way that its members openly trade futures contracts of a standardized size for standard maturity dates. Payments associated with such contracts are handled by a clearing-house. Once a contract is struck, the clearing-house interposes itself between buyer and seller, becoming the counter-party of both sides of the contract. Consequently it absorbs the full credit risk from the market and only the exchange risk is left with seller or buyer. Exchange houses act solely as brokers and charge sellers and buyers a fixed commission for each deal, which covers the cost of entering into a contract and that of terminating it. Unlike forward contracts, which establish ownership with regard to the contracted amounts, future contracts do not constitute ownership, but only an obligation to buy or sell a fixed amount at a fixed date at the specified rate. In recognition of default risk, the clearing-house requires traders to put up a deposit called ”initial margin”, in order to ensure that the terms of the contract are respected by the traders. The initial margin is set by the clearing-house and varies between 0,1 and 3 percents of the contract value. At the end of the business day, the clearing-house calculates the gains or losses experienced by market participants as a result of changes in the value of their respective futures contracts; these gains and losses, called ”variation margins” are added to or subtracted from the future margin accounts market participants are required to hold with the clearing-house. Futures markets allow traders to match foreign exchange payments or receipts at an uncertain date in the future with corresponding specific obligations in the future market, because traders can close out their obligations in the futures market by an offsetting sale or purchase on any business day before maturity. In practice only 95 percent of futures contracts are closed out by offsetting contracts, and only a small fraction is settled through actual delivery at maturity. Because of their standardization and high liquidity, futures are often more attractive than forward markets to small participants, which do not have access to the open forward market, while large scale operators may also find futures more attractive, because they are more flexible and anonymous. The main targets of futures contracting are hedging and speculations on the price. Closing of a futures contract does not impose any cost to investors (excluding commissions), but the clearing-house makes claims on them. To reduce excessive speculations and improve the execution of futures contracts, Stock Exchange imposes the limits of the total volume of futures contract opened by an investor (limitation of position), as well as the limits for every type of futures contract on price fluctuation during trading day against previous day. In case of over passing the settled limits the transactions are being stopped (cessation takes place). This operation gives inves-tors the possibility of reevaluating market environment. Limitation of price fluctuations reduces, on the one hand the risk of losses and bankruptcy, on the other – reduces the liquidity of the futures contract for the period when Stock Exchange is being closed. Futures transactions can be classified as: 1. Commercial futures transactions with commodities (common for the Exchange of goods); 2. Futures transactions with financial instruments:  With currencies;  With exchange rates on different financial titles (futures contracts for bills, bonds);  With synthetic derivatives (futures contracts for shares and share price index); “Futures” with currencies - Such contracts establish the exchange rate of a certain currency for a well-determined sum (at delivery or purchase) at a future date, when buyers and sellers respectively, ingage themselves to buy or deliver the underlying currency.It allows insurance against the risk of exchange rates and speculations. “Futures” with exchange rates – settles the price of the underlying item at the delivery (selling) or at the receipt (buying) of it at a future date. The risk of rising up of exchange rate is covered by the selling of “futures”; that of lowering – by the purchase of “futures”. The obtained profit out of selling “futures” and re-buying them less expensive (when rates go down) compensate the losses out of the increase of the rates on the market.These contracts allow investors to protect themselves from rate of exchange’ fluctuations. “Futures” with synthetic derivatives – are contracts of engagement of the delivery of a certain sum of money equal to a well-determined index at a fixed maturity. These contracts are used as instruments of coverage against speculations. Futures contracts are used in order to create different strategies – so called spreads, which represents the simultaneous opening of long and short positions on future contracts. Investors use the strategies when presuming that the difference of prices on different future contracts does not correspond to reality. Spreads generally fall into two broad categories: 1. Time Spread-based on simultaneous buying and selling of future contracts on the same asset, but with different maturity. The main goal is gaining profit out of changes of prices of futures contracts. 2. Asset Spread-focusing upon the closing of different future contracts on different, but interconnected assets, gaining profit out of price fluctuation. 1.2. Options Contracts Options first appeared a couple of centuries ago, in the form of transactions that were not to be obligatory finalized, only if necessary. Up to 1973 there could be found only simple transactions with classical options. Negotiable options appeared the same year in Chicago, at CBOE (Chicago Board Option Exchange). If classical options kept counter-parties connected up to the maturity of the contract, negotiable ones gave the possibility of the introduction of the third party (to whom options were sold or purchased from), this way contractors having the chance of closing their positions independently, until liquidation. In order options to be negotiable, there had to be introduced services of the clearing-houses, which kept account of “options” contracts, insured and guaranteed fulfillment of both sides’ obligations. Options contract – represent the contract that gives to one of the counter -parties the right to choose between the execution of the contract and the rejection of execution. These contracts reduce investment risks and do not impose any limit on profit. According to international practice, options contracts can be negotiated on different assets, such as: stocks, indexes, coupon securities, foreign currency and commodities. In the transaction takes part two counter-parties – one is buying the option contract (buys the right to choose), the other one is selling it (grants the right to choose). The buyer makes payments to the seller in the form of a premium for the right to choose. Subsequently the seller is to fulfill contract duties from his side, in the case of execution. The buyer has the right to sell and respectively buy the asset at the execution price, indicated in the contract. The buyer of an option pays a premium to the option writer. This premium is defined in the contract and depends, inter alias, on the exchange rate at which the option may be exercised – the exercise or strike price, standardized as well. The system of strike prices allows option buyers to choose the extent to which they want to limit their market risk. As writers of a currency option are exposed to an unlimited market risk, they are required to put up a margin, which is set by the exchange according to whether the option would provide the buyer currently with a profit or a loss when exercised. Options contracts are closed at Stock Exchange and OTC market. In the second case, contracts are executed through brokers or dealers, not being standardized, fact that reduces the secondary market. Brokerage compa-nies, respectively guarantee execution of contracts. Trading at Stock Exchange is mostly attractive for investors, being similar with the futures contract trading. The roles of intermediary play the market makers (buyers and sellers that announce their quotations). The system is very liquid, as in every moment of time it is possible to purchase or sell a certain contract. The high liquidity is also insured by the standardization of the options contracts. Currency options give the holder the right to buy (call option) or to sell (put option) a currency at a given price at a future date, but do not oblige the holder to exercise this right. Options that can be exercised at any time between the date of writing and expiration date are called “American options”; options that can only be exercised at maturity are ”European options”. As in the futures market, option contracts are typically for standard amounts and expiration dates and, are traded either on an organized exchange or in the over-the-counter market. Options exchanges exist in Chicago (CBOE; CME), London (LIFFE); Amsterdam, Bangkok, Montreal, Philadelphia, Singa-pore, Sydney and Vancouver Currency options enable the buyer to limit the market risk when it is uncertain whether (American or European options) or when (only American options) they will actually make a foreign transaction in the future, or alter-natively, when they have a strong option about future currency movements. The premium for a currency option represents the cost at which they can insure themselves against the risk resulting from exchange rate fluctuations. Range Forward Options – typify a number of more sophisticated market instruments that have been developed recently. They are offered by a large number of investment and commercial banks to enable the buyers to limit their potential exposure to exchange rate risk to a margin around a specified rate. A Range Forward contract defines a floor and a ceiling for the exchange rate, beyond which the buyer may exercise his option to buy or sell foreign exchange. As these contracts are constructed by combining the sale of a call option and the purchase of a put option (or vice-versa) in such a way that the net premium amounts to zero, bank customers are not required to pay premiums when entering into contract, while the bank usually profit by offering a smaller range to the customer than the range they obtain in the exchange. The major difference between forward and options contracts is that, whereas either party to a forward is a potential debtor, the buyer of an option acquires an asset, and the option writer incurs a liability. However, the option may expire worthless; the option will be exercised only if settling the contract is advantageous to the buyer. Options are written on a wide variety of underlying items (as mentioned above) such as equities, commodities, currencies, and interest rates (inclu-ding cap, collar, and the floor: A cap places an upper limit, a floor – a lower limit, and a collar – upper and lower bounds on floating rate interest payments/receipts). Options are also written on futures, and swaps (known as swaptions), and other instruments such as caps (known as captions). On organized markets, options contracts are usually settled in cash, but some option-type contracts are normally settled by the purchase of the un-derlying asset (for example: warrants (a particular form of option) are fi-nancial contracts that give the holder the right to buy, under specified terms, a certain number of the underlying asset, such as equity shares and bonds. If they are exercised, the underlying asset is usually delivered. Warrants can be traded apart from the underlying securities to which they are linked.) Spread options that represent contracts whose value is derived from the interest rate spread between a high quality credit and a lower quality one (for example: if the spread narrows sufficiently, the option holder benefits from exercising the option). As in futures case, options can be used to create several strategies that are based on simultaneous buying and (or) selling of several options contracts: combination and spread. The first one represents a portfolio of different types of options contracts on the same asset with the same maturity, the price of execution being different or equal. The second one represents a portfolio of options contracts of the same type on the same asset, but with a different execution price or maturity. Both strategies are used in order to hedge positions on stocks. 1.3. Swaps Contracts The traditional form of currency swap generally denotes a combination of a purchase (sale) in the spot market and an offsetting sale to the same party (purchase) in the forward market; but it may sometimes refer to offsetting transactions at different maturities, or combinations of both. A swap is a contractual agreement involving two parties who agree to exchange, over time and according to predetermined rules, streams of payment on the same amount of indebtedness. In general, the swaps may be analyzed as a portfolio of forward con-tracts closed between two contra partners. Swaps are frequently combined with credit transactions to exploit inte-rest differentials while simultaneously hedging against exchange risk. Banks and multinational corporations to match the structure of their cur-rency holdings or obligations to the expected payments flows in the res-pective currencies in order to limit their exposure to exchange rate risk often use them. Swap transactions combining a purchase (sale) in the forward market for one maturity and a sale (purchase) in the forward market for a different maturity are called “forward/forward” swaps. Recently, a new form of currency swap has emerged (Instead of operating in the forward market, a domestic company may sell a certain amount of foreign currency to a foreign company and simultaneously enter into agreement to reverse the transaction in the future at the same spot rate underlying the initial transaction). Usually this kind of swap occurs in the framework of a credit swap agreement. The most prevalent varieties of swaps are: 1. Interest Rate Swaps - involves an exchange of interest payments of different character (e.g., fixed rate and floating rate, two different floating interest rates). It includes exchange of liabilities with fixed interest rate on liability with variable interest rate. Counter-parties exchange only interest payments but not the principle, payments being made in one currency. Usually the maturity varies between 2 and 15 years. Usually as variable interest rate is used LIBOR (London Interbank Offered Rate), used as reference interest rate for borrowing at international financial markets and being calculated for 360 days. Interest rate swap is closed if the issuer of liability at fixed interest rate is expecting a decline of interest rate, exchanging in the result fix liability on variable one. Initially the main goal of Swaps was the arbitrage possibility between the market of bonds with fixed interest rate and that of short-term loans, characterized by variable interest rate. Due to different evaluation of future development Swaps will always be in demand. 2. Currency Swaps - tackle an exchange of specified amounts denomina-ted in two different currencies and subsequent reflecting principal and/or interest. It represents an exchange of face value and interest in one currency on face value and interest in other one. Demand for currency swaps may be created by some restrictions on transactions with foreign currency, initiatives to reduce foreign exchange risks or to issue bonds in other currency. 3. Asset Swaps consists in exchanging of assets in order to create a synthetic asset that will increase profit. It assumes the exchange of assets with fixed interest on assets with variable interest, or exchanging assets in one currency on assets in other one. 4. Commodity Swap represents an exchange of fixed payments on varia-ble ones, related to the price of commodity. It is similar to interest rate swap where fixed payments are exchanged on variable ones. Commo-dity Swaps are more attractive with permanent stability on commodity market. 5. Basic Swap presumes the exchange of principles calculated on the base of variable interests rate. 6. Depreciable Swap – decrease of face value in time. 7. Increasable Swap – increase of face value in time. 8. Delayed (Forward) Swap – contract that stipulates that the exchange of interest will begin sometime in future. 9. Circular Swap – exchange of fixed interest payment in one currency on viable interest payment in other one. 10. Prolongation Swap – one counter-party gets the right (option) to prolong the swap maturity. 11. Dischargeable Swap – one counter-party gets the right (option) to discharge the option before maturity. 12. Index Swap – payments are correlated with an index – consumer price index/the index of a bond or stock. There are also known:  Foreign Exchange Swap contracts that represent a spot sale/purchase of currencies and a simultaneous commitment to a forward purchase/ sale of the same security.  Cross-Currency Interest Swap contracts (sometimes known as ”cur-rency swaps”) which involve an exchange of cash flows and an exchange of principal amounts in specified currencies at an agreed exchange rate at the end of the contract. Section II: Forward Markets in Industrial Countries. Regional Peculiarities, Evolution and Development of Forward Markets Forward exchange markets in industrial countries in the 1980’s have shown a substantial reduction of government regulation and intervention, and increasing innovations in financial instruments. New markets were established by Central Banks in Ireland and New Zeeland at the beginning of the 1980’s, and in Finland in the 1970’s. There have been taken major steps to broaden access to their forward markets for France, Japan, and Spain. Systems for forward cover against exchange rate risk exist either in the official or the commercial sectors in most members of the International Monetary Fund. However, the form of arrangements varies widely from one country to another. Only a few industrial countries continue to limit access to forward markets to certain transactions, and in all these countries the forward rate is market determined. Iceland is the only industrial country without such a market. Forward markets that were in place before 1980’s were considerably liberalized. Austria and Japan completely removed requirements for an underlying commercial or financial transaction. Maturity restrictions have been eliminated in France and relaxed in Austria, Denmark and Italy. Access of financial institutions to forward markets has been expanded in Japan and Sweden, while restrictions on the banks’ net positions were eased in Spain. Where restrictions have been retained, they were aimed lar-gely at reducing speculation against the currency. Forward exchange markets, particularly in the less regulated envi-ronments, have been marked in recent years by rapidly increasing of sophistication of instruments. A major early innovation was the market for foreign currency futures, launched in 1972 in Chicago at the International Monetary Market. The main contribution of this type of market was seen as greater standardization of cover and ease of liquidation, compared with the forward market. Currency options introduced in 1978 on the European Option Exchan-ge have given rise to a rapidly broadening range of differentiated financial products. They have also spread in coverage as exchanges in Montreal, Philadelphia, Sydney, London and Chicago. Subsequently the growth in the new markets has been very rapid. Within the forward foreign exchange markets there has been a recent in-flux of variations on the basic instruments (like: cylinders, collars, zero premium options, G-hedges, compound options, pooled options, break for-wards), however many participants now prefer to tailor their own specific instruments from combinations of forward, futures and options. Forward foreign exchange systems in developed countries remain diver-se, but as in the spot markets, there has been a convergence toward greater flexibility and freedom of access.