Lecture 4 - FOREX Derivatives 1 Flashcards
What are the four foreign exchange derviatives?
- Future contracts.
- Forward contracts.
- Option contracts.
- SWAP contracts.
Fluctuations in the exchange rate increase…
Uncertainties and discourages trade.
What is one solution to fluctuations in the exchange rate?
Fixed exchange rates.
What is the problem with this?
It is a problem if countries and currencies involved in the fixed exchange rate do not constitute optimal currency areas.
Markets need to create ways to reduce exposure to…
Exchange rate risk.
What is a currency forward contract?
An agreement between two counterparties to exchange a specified quantity of a specified currency at a specified future date and price.
What are some characteristics of a currency forward contract?
- Often valued at $5 million or more.
- Typically used by large multinationals.
Banks are willing to sell the forward contracts because…
They can normally diversify their risks. Banks profit on the spread.
What is a currency future contract?
An agreement to exchange a specified quantity of a specified currency at a specified future date and price.
What are the differences between future contracts and forward contracts?
- Forward contracts are of a very large size, typically $5million. This means that these types of contracts can be negotiated with banks and exchanged over the counter. The main characteristic of a future contract is that it is standardised. It is not negotiated individually but it is available in some predefined smaller sizes, typically $50,000 - $100,000.
- Future contracts are traded on organised exchanges vs forward contracts which are over the counter.
- With future contracts there is virtually no counterparty risk, it is guaranteed by the futures exchange.
- Future contracts have greater liquidity than forward contracts.
- With future contracts only major currencies are covered, compared to forward contracts where all currencies may be covered.
