Introduction
Derivatives are contracts whose value is based on the value of other assets. The most common primary types of currency derivatives are options, futures, and swaps. While they share similarities in that their value depends on other resources and creates excellent opportunities for speculating and hedging, they differ in the mechanisms that allow them to work. The primary differences between types of currency derivatives lie in the obligations and parties involved.
Futures vs. Options
The conditions of obligation are the most crucial difference between futures and options. While they both present a chance to trade the asset at a fixed price on a future date, option holders are free not to conclude the deal, whereas futures contracts must be settled. For example, the holder can refuse the transaction if the currency’s price plummets on a call contract with a high strike price (MoneyWeek, 2012). Thus, options are more flexible for the holder and can be used to hedge against risk.
Swaps
The swaps differ in their mechanisms from options and futures. While options and futures work as contracts that will get power in a future deal, swaps are based on ongoing interest rates and can lower the payer’s liabilities (Eiteman et al., 2020). An actor can swap the rates in similar deals and create mutually beneficial conditions for all parties by manipulating the different calculation methods. Therefore, the deal participants will decrease the interest payments while the swap actor receives extra value.
Conclusion
In conclusion, currency derivatives can serve different purposes and be used for speculation to gain benefits or as a hedging method to maintain a company’s value stability. In my final MNC project, I can create options that will allow me to protect the assets’ costs at a fixed rate. This will allow me to negate the damages from unexpected currency fluctuations. Additionally, I can utilize swaps to secure more favorable loan terms and mitigate interest rate risks.
References
Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2020). Multinational business finance, global edition: Multinational Business Finance (15th ed.). Pearson Education.
MoneyWeek. (2012). What are derivatives? – MoneyWeek investment tutorials. [Video]. YouTube. Web.