Too Many Derivatives from Which to Choose Essay Example | Topics and Well Written Essays - 500 words

Too Many Derivatives from Which to Choose - Essay Example The latter two methods are called as derivative markets. In this case the management does not take into account hedging using forward currency contracts as the banks have increased the charges for these services manifold. Hedging using forward contracts simply transfers the risk from the firm to the bank and hence the bank charges a large amount for these services. Now the management has to decide between currency future and options. The future currency contract is a legal contract between a buyer and a seller in which they agree to buy or sell the currency at a future date, at an exchange rate that is fixed or agreed upon today. Though the future contract looks very similar to forward contract, the futures contract brings in more liquidity it is traded in the futures market. It is similar to share market. The most important benefit of futures contract is that firm can release itself from the futures obligation by buying the contract even before the contract expires. Other benefits include liquidity, leverage and convergence of the futures price and spot price on the day of expiration of the futures contract. A currency option is a contract between a buyer and a seller where the buyer of the option enjoys the right but not the obligation to buy or sell the currency at a specified exchange rate before a specified date. There are two types of options. They are call option and put options. Call option gives the buyer the right to buy and the put option gives the buyer the right to sell the currency. Options minimize the risks to a great extent. This hedging option is not of significant importance to our book firm as the option is mainly beneficial for firms bidding for overseas projects. Options are highly flexible and offer a wide range of strategies. But they are more expensive when compared to forwards or futures contract. Hence the most suited derivative for the book firm is futures contract. The best