Question

Explain how currency forward contracts and currency futures contracts work. How might an MNC use these instruments? How might a speculator use a put or call option?

Answer 1

Solution:-

Explain how currency forward contracts and currency futures contracts work.
Currency future Contracts are one of the instruments used to hedge against currency risk. The main difference between a currency future Contracts and a currency forward Contracts is that futures are traded through a central market, whereas forwards are over-the counter contracts (private agreements between two counterparties).
How might an MNC use these instruments?
Currency futures options can be used by MNCs to hedge or by speculators to make a profit. If a call futures options is exercised, the holder gets a long position in the underlying futures contract plus a cash amount equal to the current futures price minus the exercise price.
Multinational corporations use forward contracts to hedge their expected imports. They can lock in the rate at which they will be able to obtain a currency needed to purchase imports from a foreign country.
How might a speculator use a put or call option
The power of options lies in their versatility. They can be used to speculate on market moves or to protect a position. In this lesson, we will focus on how a speculator can make use of options. The two types of options are Calls and Puts:
A Call gives the holder the right but not the obligation, to buy at an agreed upon price on expiry.
A Put gives the holder the right but not the obligation, to sell at an agreed upon price on expiry.
The agreed sell/buy price available to an option holder is called the strike rate. An option buyer will benefit if the strike rate can beat the market! If you are holding a Call option, the strike will become more attractive as the market rises, and if you are holding a Put option, the strike will become more attractive as the market falls