Currency Derivative

by J B

Puts: A put is a contract that permits the holder to sell a specific amount of a currency at a specific exchange rate. A call gives the holder the option to purchase a specific amount of currency at the strike price. An option’s capacity to be exercised expires on a date specified in the option contract. If the option is American-style, the holder can exercise it at any time before the expiration date, but European-style options only allow the holder to purchase or sell at the exercise price on the expiration day.

Swaps: Swaps are agreements between two parties to exchange currencies on specific dates. These exchanges stipulate particular parameters, such as whether the swap’s exchange rate will be fixed or floating for the term of the swap. Currency swaps and interest rates are sometimes mixed. Another sort of derivative is a swaption, which allows the holder to enter into a swap.

Forwards and futures: Forwards and futures contracts are agreements between two parties to deliver a predetermined amount of a commodity, or in this example, a predetermined amount of money, at a specified price. The most significant distinction between the two types of derivatives is that options are exchanged between private parties, whereas futures are sold on exchanges and have defined terms.

These foreign currency derivatives are traded by international firms to protect themselves from negative changes in exchange rates between the currency in which production costs are paid and the currency in which they are paid. The corporation locks in an exchange rate by purchasing futures, which protects them from losses caused by changes in the exchange rate.

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