Currency Future Contracts - Essay Example

Some buyers and sellers of the instrument used it for speculation. The named instruments are not only used to hedge against unfavorable movements in the value of currency but also in other economic factors such as interest rate, exchange rates and natural calamities (CME group, n.d .). These contacts are reliant on some underlying assets thus are called the derivatives. First, swap is a derivative that involves an agreement between two or more traders to exchange the denomination of their cash flows.

For instance, consider two investors from the US and the UK, who have invested in the local government securities. The two investors would agree that the US investor receives the cash flow of the UK investor, denominated in Sterling pound. The same would happen to the UK in investor. Secondly, an option is a contract that grants the buyer rights but not an obligation to participate in the contract, on maturity. On the other hand, the contract obliges the seller to participate when the contract matures.

Thirdly, a forward is a contract between the counterparts to exchange currencies at a predetermined exchange rate. That is, the parties agree to exchange their currency at a given exchange rate agreed now, but during a future transaction, say after one year. Lastly, a future is a contract between parties to exchange currencies in the future, at a pre-determined rate. The nature of the contract is similar to that of forwards. The only difference is that futures are exchange traded whereas; the forwards are traded over the counter (CME group, n.d .).

Have the current future prices fallen or risen? In the recent past, the currency future prices have demonstrated a downward trend. The reduction of the prices is said to have been caused by a high level of uncertainty about the future prices. Another reason for the fallen prices is the deteriorating US economy (CME group, n.d .). Types of exposures Most companies sign future contracts mainly to hedge against the unfavorable move of the exchange rates. A volatile exchange rate presents an environment that is too risky for businesses to operate.

The risks are categorized into a transaction, operating and translation. A transactional exposure arises from the various trading activities that a company engages in. Globalization has made the world a small village where companies in the various parts of the world are well connected. The process of globalization has facilitated the sharing of resources between different companies. Businesses that operate in the international markets face greater risk of future price movements. This is because they borrow, lend and invest in those markets using foreign currencies.

It is from the trading activities of a business that transactional risk arises. Secondly, operating risk is the adverse changes in a company’s revenue elements due to unfavorable movements in the currency prices. For instance, the prices of caterpillar tractors were at one time high in the international market because the US$ gained more strength against other currencies. Other countries had to give up more of their currency in exchange for one dollar. This situation caused the tractors to be more expensive as compared to the competitor’s (Rheinla?

nder & Sexton, 2011). During the period, the caterpillar company recorded lower sales due to the influence of the currency price fluctuations. Lastly,