Lil more on derivatives….

I wish to add to what Shelly has talked about…..Derivatives are an excellent tool for managing the risks associated with the market fluctuations.

As stock derivatives, there are currency derivatives which are available.

Apart from other risks, Foreign Trade is subject to risks from currency fluctuations. Exporters and Importers in order to safeguard themselves against unfavourable currency fluctuations use currency derivatives as a hedging mechanism.

In case where an importer has to make payments in a foreign currency to the exporter at a future date, he can invest in a buy (long) position for currency futures by paying a premium. On the date when the payment is due to be made by the importer the required currency amount is available at the strike price of the currency futures. Hence, the importer is safeguarded from the any depreciation in the value of his currency.

Similarly, where an Exporter is expecting payments from the importers in a foreign currency, they can invest in a sell (short) position for currency futures in which payment is to be received. When the payments are received by the exporter even if the domestic currency has appreciated in comparison to the currency in which payments have been received the exporter does not suffer any losses. The exporter can accept the payment and the sell the currency in the derivative market at the pre decided strike price.

The buying and selling of currency futures does not help the exporters and importers earn any profits. However, they enable them lock in the exchange price of the payments to be made and received. This helps importers and exporters keep up with their estimated budgets and forecasted revenues.

Hope u find it interesting..
Kriti