Foreign Exchange Derivatives (Currency Futures/Currency Options)

Definitions

  1. Financial instruments to manage exposure
  2. A financial instrument whose value depends in its underlying asset
  3. Traded on exchanges or over-the-counter

Features of Future Contracts

  1. Traded on exchanges
  2. Standardized instruments
  3. Most future contracts do not run to their final settlement date (if they do, they either settle it through a cash settlement or physical delivery)
  4. Can be used for hedging and speculating

The Role of the Futures Exchange

  1. Decide on the specifications of the contracts
  2. Credit risk is reduced due to the initial margin
  3. Additional deposits are called variation margin
  4. Clearing house reduces counterparty risk

Currency Options

  1. An agreement between two counterparties in which the option buyer pays the seller a premium for the right but not the obligation to buy or sell a specific quantity of a specified underlying instruments on or before the agreed date at an agreed exchange rate

Users of Currency Options

Importers and Exporters

  1. Overseas contract – foreign currencies
  2. Long delay, tender

Banks and Corporate Customers

  1. Fix a definite exchange rate
  2. Take advantage of favorable currency exchange rate movements

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