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International Financial Management - Assignment Example

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The market that deals with the purchase and sales of commodities, securities and currencies at prices that is agreed and fixed upon today through a contract, is known as forward market. Thus, it helps the MNCs to block the exchange rate. This prevailing exchange rate is known as…
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International Financial Management
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International Financial Management

Download file to see previous pages... Hedging is one feature of the forward market. MNC’s. Hedging the amount that they are supposed to receive or pay in foreign currency will make the spot rate unimportant for them till their future payment. There is very little difference between the forward and future market. But the differences are very important. Unlike the forward market, which is characterized by personalized contracts with no initial payment necessary, future market have standardized contracts with at least marginal payment paid initially. This implies that the amount that is being transacted can be of any value. Future contracts specify the volume of a particular currency to be used for transaction at the specified date. Secondly, for forward contracts there is no organized exchange present in the future contracts as the contracting parties directly do the transactions. Thirdly, the contract size depends on the contracting parties in case of the forward contracts. But, for the future contracts, contract size is standardized. Fourthly, future contracts are government- regulated and bears low risk while forward contracts are unregulated and are high-risk bearing as there are chances of default. (Madura 2009, pp. 108-110) 
Speculators purchase currency futures to capitalize their expectation about the ups and downs associated with respect to currency movement. Suppose a speculator expects appreciation of a particular currency in the future. They can then buy future contracts and hence lock the price of that currency for a specific settlement date. On this date they can buy their currency at a rate specified in the futures contract and sell it at the spot rate, which is less than the rate specified in the futures contract. If the spot rate has appreciated, then they extract profit. Different expectations of the speculators guide their decisions to sell and purchase future contracts.
Corporations use currency futures to hedge and thus reduce their ...Download file to see next pagesRead More
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