Forward Contract, Futures Contract, Currency Options - Essay Example

A futures Contract is an exchange-traded agreement to purchase or sell a particular type and grade of the commodity to be delivered at an agreed-on place and time within the future. Futures contracts can be transferred between parties. Futures have advantages similar to those mentioned for forwards.

Currency Options involve a contract for a fee (premium + commission), sold by one party to another that provides the buyer the right, although not the obligation, to purchase or sell a specified amount of a single currency for a given amount in another at an agreed-on price within a given period or on an exact date. Its advantage is that it protects against downside risk in addition to allowing upside appreciation.

Currency Swaps on the other hand are an agreement by two corporations to exchange specified amounts of currency currently and to reverse the exchange at a given point in the future. A currency swap might not incorporate an initial exchange, in which instance it would incorporate one or multiple payments during the swap’s life in addition to a final exchange. This option helps in minimizing the costs of foreign conversion while the client is secured against exchange rate risk. Additionally, it costs nothing to enter into a swap.
Back-to-Back Loans are a form of loan where two corporations in different nations borrow offsetting amounts in an individual’s currency. This transaction aims to hedge against fluctuations in the currencies. Its key benefit is that it allows one to gain from approved spot limits.

A Non-deliverable forward contract is a form of agreement between parties where one (an individual) is protected against undesirable rates in foreign exchange. Generally, it is a cash-settled transaction and as such there are no real exchanges of currencies at maturity. Essentially, a net payment is made by one of the parties to the other on basis of the contracted rate alongside the market rate on the day of settlement. It effectively involves the hedging of expected foreign currency cash flows. Simply put, a contract rate is agreed up-front, alongside the fixing rate (and the corresponding fixing date).

The contract rate is made use of in the calculation of the amount payable on the nominated date of maturity.
It is important to mention that an NDF may be useful in the management of currency risks related to the exportation and importation of goods, foreign currency purchase, conversion of foreign currency-denominated dividends, or in settlement of other foreign currency contractual agreements. It is particularly useful in instances where the physical exchange is not necessary on the maturity date or in instances where a foreign central bank puts some limit on offshore access to its local cash niche. It should be put into use in instances where one has a genuine commercial necessity to manage currency risks linked to a particular pair of currencies.

Q2:
The strike price of an equity option in popular plc is 380p and the premium was 24p per share. The current market price of a share in the company is 410p. The exercise date is still over one month away.

Calculate the profit or loss on one contract to date for:
A long call
410p- (380p+24p)
410p-404p
= 6p profit
A long put
(410p-380p)/410p×100
=7.3p

A short call
(380p+24p)-410p
-410p+404p
=-6p

A short put

410p-(380p+24p)
= 6p

If the market price of shares in popular rose explains how, and why, the premium would alter as a result for:
i) a long call
The profit made by the trader will increase. This is because the trader will still be able to purchase at a relatively lower price.
ii) a long put

The profit made by traders will increase.
Transactions involving currency exchanges are often susceptible to currency rate fluctuations. Such can hugely diminish the profits one makes from a given transaction. Such fluctuations can result in extremely huge losses in instances where precaution is not taken in advance. Various hedging arrangements are put in place to minimize such a risk. These include forward contracts; which theoretically, are intended for customers who want to fix a desirable current exchange rate based on a pre-defined future date and futures; they are standardized about standard volume which is to be exchanged on a settlement date identified in the future.

The standard volume refers to non-tailored transaction amounts being able to be traded on markets, currency options; which is regularly used as hedging instrument given that it guarantees a worst-case exchange rate for a given future currency purchase for another and are also contracts although they cost more as compared to forward contracts, and currency swaps which are also very popular and applicable to long term period with raised volume under an ensured high liquidity. It is important to note that whenever getting into a currency swap, the client engages in simultaneously purchasing and selling a given currency at a given fixed exchange rate after which he/she re-exchanges the currencies at a future date. This allows one to engage in the conversion of a stream of cash flows in a given currency to another currency at a specified exchange rate.  Read More