How does Forex Insurance Work?
What is forex insurance?
The concept of insurance is not a foreign one to many, as all adults should be familiar with it and what it entails. Many people take out insurance for high-value items such as vehicles, property, home contents, assets, travel, pets, and just about any valuable goods that they may have. Insurance acts as a way of safeguarding you against unprecedented occurrences and damages, such as theft and accidents in most cases. Therefore, the concept of insurance remains the same when introduced in the world of trading, and more specifically, forex trading. Some brokers offer forex insurance for the above-mentioned reasons, to provide additional security and protect clients from potential financial loss during trading activity. Now, it is important to note that the potential financial losses are not those that arise from regular trading activity and the markets, as that is a risk that is invariably associated with trading or investing in forex. Instead, forex insurance is an arrangement that is made to safeguard against errors, omissions, negligence and fraud, amongst other related incidents.
Some brokers take it a step further and go as far offering fraud awareness and prevention programmes, this can be viewed as an extension of their efforts to affirm that they offer secure and reliable forex trading services and options. This is particularly important because the growing interest in trading has prompted many fly-by-night brokers who may be looking to take advantage of vulnerable and naïve investors.
Risks associated with forex trading
As with any investment or trading endeavour, there is a certain level of risk that is associated with forex trading. Perhaps one of the most notable of those are the transaction risks that exist. These are sometimes referred to as exchange rate risks which relate to the time differences between when a contract or trading agreement is entered into and when the settlement date is. Given that the forex market is operational 24/7, despite the different trading hours for various currencies, this presents additional risk in light of unprecedented market and global conditions that may occur at just about any time. Additionally, counterparty risk remains a cause for concern. This refers to the risk of default on a particular transaction. Therefore, during volatile market conditions, the counterparty, which is the entity that provides the asset to the investor, may be unable or refuse to adhere to contracts.
Because of the risk and currency fluctuations associated with trading, forex insurance can be described as “a forward operation involving the buying and selling of currencies that has the effect of eliminating the uncertainty arising from any future payment or collection of payment to be carried out in a foreign currency.”
The contract is therefore signed by a financial institution and a trader or investor (in some cases the importer/exporter), and it ultimately creates two main obligations. Firstly, on the part of the trader or investor, the obligation is to sell/buy from the bank the currency of the operation on a specific date. On the part of the bank, the obligation is to buy from/sell to the trader the transaction currency at a fixed exchange rate agreed at the time the contract was signed, regardless of the quoted rate prevailing at the time of the payment.
