Futures, Forwards and Option markets

 

A forward contract is a non-standardized contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today, making it a type of derivative instrument.

A forward market for currencies enables a Multi-National Corporation (MNC) to lock in the exchange rate (forward rate) at which they would buy or sell a currency. A forward contract specifies the amount of a particular currency that would be purchased or sold at a future point in time. Commercial banks and MNC’s would desire to have forward contracts. MNC’s use forward markets to hedge future payments that they expect to make for future receipts from their exports which they expect to receive from a foreign currency. It enables them not to mind about currency fluctuations in the spot rate until the time of the future payments or when forex receipts are made.

 

 CURRENCY FUTURE CONTRACTS

There are similar to forward contracts except that they are sold on an exchange, whereas forward contracts are offered by commercial banks. A currency future contract specifies a standard volume of a particular currency to be exchanged on a specific settled date I.e. They’re held in multiples or bundles of a given currency e.g. Pounds

 

CURRENCY OPTION CONTRACTS 

They’re classified as calls or puts so that a currency option provides the right to buy a specific currency at a specified price otherwise called the strike price or exercise price within a specific period of time. It is used to hedge future payables. A currency pool option provides the right to sell a specific currency at as specified price to hedge future receivables. As both a call and a put option can be purchased on a securities exchange, they offer more flexibility that forwards future contracts because they do not require any obligations. I.e. The form can elect to exercise the option or not if it so desires.

INTERNATIONAL BOND MARKET

 In addition to issuing bonds/debentures in their local markets, MNC’s can access long term funds in foreign markets. International bonds can be classified in to two:-

Foreign bonds are issued by a borrower foreign to the country where the bond is placed. I.e. A Kenyan company may issue a bond denominated in Japanise Yen which is sold to investors in Japan.

Euro bonds  are sold in countries other than the country of the currency denominating the bonds. E.g. Safaricom issuing a bond denominated in US dollars in a country other than the US e.g. France