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Chapter 9

Derivative products

3.1 Introduction

Hedging methods relating to currency risk and interest rate risk are covered in the
next two chapters. Many of the hedging methods use 'derivative products' (e.g.
futures contracts, options, swaps) to reduce the firm's exposure to risk.

3.2 The basics of futures contracts

A futures contract is an exchange traded forward agreement to buy or
sell an underlying asset at some future date for an agreed price. There
are two ways of closing a futures position:

 Deliver the underlying on the maturity date – RARE.

 If futures contracts have been bought, then equivalent contracts
can be sold before maturity, resulting in the company having a net
profit or loss (and no obligation to deliver).

Hedging is achieved by combining a futures transaction with a market
transaction at the prevailing spot rate.

Illustrations and further practice

Now try Illustration 3 and Illustration 4 from Chapter 9

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