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Hedging foreign exchange risk

Currency futures

6.1 Features

 Standardised contracts to buy or sell standardised amounts of an
underlying asset at a pre-determined price in the future.

 In some respects futures sound similar to forward contracts except
futures contracts are rarely used to deliver. Instead a futures
position is opened and, later, closed out to leave a net gain or
loss.

 The idea is that any gain or loss in the market is matched by a
corresponding loss or gain on the futures position, thus reducing
the risk.

 Standard expiry dates – the last day of March, June, September
and December.

 All buyers and sellers are required to pay an initial margin
(deposit) to the exchange when they set up a position.

 Gains and losses are 'marked to market' on a daily basis and the
initial margin adjusted if necessary.

6.2 Advantages and disadvantages

ADVANTAGES DISADVANTAGES

 Effectively fix the exchange rate  Not for precise tailored amounts

 No transaction costs  Require up front margin payments

 Tradable

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