How do spot and forward contracts affect market liquidity in the foreign exchange market?

Spot and forward contracts are important tools in the foreign exchange market that help determine how easily money can move in and out of different currencies, which is known as market liquidity. A spot contract allows traders to buy or sell a currency at the current market price for immediate delivery, making it easy for them to enter or exit positions quickly. In contrast, a forward contract locks in a price for a currency to be exchanged at a future date, which can reduce immediate liquidity because it ties up capital until the contract matures. For example, if a company needs to pay a foreign supplier in three months, it might use a forward contract to secure the exchange rate now, but this means its funds are not available for other uses until then. Overall, while spot contracts enhance liquidity by allowing quick transactions, forward contracts can decrease it by delaying currency exchanges.