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CURRENCY CONTRACT

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Currency Swaps

A currency swap is a transaction between two parties inwhich one party promises to make a series of payments toother party at specific dates in exchange for a payment

from the other party in different currencies. Currency swaps can be used by firms that operate in one

currency but need to borrow in another currency.

In currency swap, one party holds one currency and swaps

it for another currency held by the other party.

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FOREIGN CURRENCY FORWARD COVER

The Commission observed that forward foreign currency coverswill be permissible subject to the following conditions:

i) The amount of foreign currency is needed for genuine trade

or payment transactions. The need will have to be supported byappropriate documents so as to prevent forward cover forspeculative purposes.

ii) The forward cover shall be through an agreement to sell orpurchase and it shall not be a sale and purchase agreement. Itmeans that sale/purchase shall take place simultaneously at the

agreed time in future at the rate agreed upon initially at the timeof agreement to sell or purchase.

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FUTURES CONTRACTS

FUTURES CONTRACTS

I. CURRENCYFUTURES

A. Background

1. 1972: Chicago Mercantile

Exchange

opens International Monetary Market. (IMM)

2. IMM provides an outlet for hedging currency risk with futures contracts.

Definition of futures contracts: a standard quantity of an available currency

at a fixed exchange rate at a set delivery date.

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FUTURES CONTRACTS

Advantages of futures:

1.) Smaller contract size

2.) Easy liquidation3.) Well-organized and stable market.

Disadvantages of futures:

1.) Limited to 7 currencies2.) Limited dates of delivery

3.) Rigid contract sizes.

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CURRENCY OPTIONS

I. OPTIONS

A. Currency options

1. offer another method to hedge exchange rate risk.

2. first offered on Philadelphia Exchange (PHLX).

3. fastest growing segment of the hedge markets

Definition:

a contract from a writer ( the seller) that gives the right not the

obligation to the holder (the buyer) to buy or sell a standardamount of an available currency at a fixed exchange rate for afixed time period.

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Contracts fixed in foreign currency

If the firm has contracts fixed in foreign currency terms, it will be

affected by exchange rate risk even if relative prices are

unaffected and PPP holds.

Examples are debt with fixed interest rates, long-term leases,

labor contracts and rent.

However, if real exchange rates do not change, what we see

here is really inflation risk and not forex risk. That is, the same

effect can occur domestically, as well.

If contracts are indexed and if the real exchange rate remains

constant, forex risk is eliminated.

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I dipt into the future far human eye could see, Saw the vision ofthe world and all the wonder that would be

- Thank You