WHAT ARE CURRENCY DERIVATIVES?

Derivatives are anything that derives its value from underlying assets or securities. These assets can be anything securities, commodities, bullion, currency etc. In other words derivative is a butter derived from cream. They are distinguished product that helps in hedging the portfolio against the future risk and are optimistically used for speculation and arbitrage.

Currency derivatives are the future and option contracts which can be bought and sold. They are the blessing in disguise for the importers, exporters and the companies who trade globally. They match the needs of the customers and thus they have wide range of scale. The value of the currency determines the value of the derivatives.

A clear cut opinion that markets risks need to be managed with time tested tools that cause elimination of the market risk and Currency derivatives are the expedient tool that manages risk in Forex market. Currency market is known for its buoyancy and with unpredicted and sudden movements of the currencies resulting in corresponding changes in the interest rates has made Derivatives as the most sought option by the importers and exporters to shield their position by buying appropriate derivative products.

Derivatives with currency as the base are known as Forward Contracts which contract determines the rate at which exchange takes place between two currencies on a particular date in future. Individuals who trade globally go for these derivatives to safeguard their stand by entering agreement with the banks.

Foreign exchange derivatives are a financial derivative whose settlement is counted on foreign exchange rates of two or more currencies. They are normally used in speculating currency, arbitrage or hedging risk caused by foreign exchange. Financial instruments that fall in this category include:

·         Currency option contracts: It is the option in which the underlying asset is the foreign currency. It gives the holder the right but not accountability to trade a set amount of currency at certain exchange rate on or before expiration date.

·          Currency swaps:  It is a foreign exchange agreement in which two parties to exchange     obligations pertaining to a particular loan in one currency for same aspects of equal in net present value of the loan in another currency.

·          Forward contracts: It is the type of agreement when two parties agree to buy or sell some underlying asset on same future date at a stated price and quantity.

·          Future contracts: It is financial contract that derives its value from underlying asset.

Foreign currency derivatives are used by the hedgers to alleviate the risks by cushioning themselves against potential price fluctuations future. They are also used for hedging to protect sales revenue. These derivatives offer comparatively lower trade spreads and have lower transaction costs.

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Created on Dec 31st 1969 18:00. Viewed 0 times.

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