In Part I, we discussed along with examples the two most commonly used currency trading products; Spot and Forward. Chicago Mercantile Exchange introduced currency futures in the year 1972 immediately after the gold standard was abandoned by the U.S President Richard Nixon. Currency trading is becoming increasing popular as the investors who are disappointed with bonds and securities are usually keen to try their luck in the currency market. Derivative products facilitate hedging of currency volatility risk and opportunity to make speculative profits. Currency futures contract is an agreement between two parties made through an organized exchange.
It is a contract that grants the holder of the option the right, but not the obligation to buy or sell a currency at as a specified exchange rate during the specified period of time. In foreign exchange swap, one currency is swapped against another for a short period of time, and then the same is swapped back, this creates an exchange and re-exchange.
It will be seen that currency trading is not only done for hedging the currency risk but also to gain a speculative profit.

Investors typically use a futures contract to hedge the currency risk and traders use them to make speculative profits. Call option is the right to buy the currency and a Put option is the right to sell the currency. Xavier gains a profit of JPY 500.00 which is the cost (premium) of the option he sold, which is the same as the amount lost by Miss Lin Fin Tau in this entire transaction. This derivative instrument is commonly by the regulating bodies of the economies to manage their monetary policy, for instance, governing and regulating authorities can restrict and inject the circulation of the desired currencies in the markets by entering into foreign exchange swap transactions with the banks. Futures contract have to abide rules and regulations laid down by the futures exchange and the regulating bodies. It is important to remember that the holder of an option be it Call or Put has the right to exercise it but is not obliged to do so. The contract is for a specific amount of a specific currency to be bought or sold at a specific future time determined by the exchange.
The seller or the writer of the option is liable to take the delivery if the buyer decides to exercise the option he holds.

In principle a foreign exchange swap is a combination of a spot and a future transaction as it has one deal rate for the ‘near date’ and another deal rate at the ‘far date’. The difference between today’s futures price and yesterday’s futures price is the inter-day or intermediate loss or gains. Foreign exchange swaps are most suited to companies who have an excess of one convertible currency and need another convertible currency. Futures contracts can be traded on any day or on the range of dates even before the expiry. Every futures exchange as a clearing house that takes care of the transaction once the trade is completed. Parties entering into a futures contract are required to deposit margins with the exchange to demonstrate their ability and capacity to pay and fulfill their contractual obligation.

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