Chapter 5: Currency Derivatives

Flashcards covering key concepts related to currency derivatives, including definitions and explanations of important terms.

Currency Derivatives

Contracts whose value is derived from an underlying currency. They are used to hedge exposure to exchange rate risk and speculate on currency movements.

Forward Contract

An agreement between two parties to exchange a specified amount of currency at a specified exchange rate on a specified future date.

Futures Contract

A standardized contract traded on an exchange to buy or sell a currency at a specified future date.

Call Option

A financial contract that gives the owner the right, but not the obligation, to buy an underlying asset at a specified price.

Put Option

A financial contract that gives the owner the right, but not the obligation, to sell an underlying asset at a specified price.

Hedging

A strategy used to offset potential losses in investments by taking an opposite position in a related asset.

Speculation

The act of purchasing or selling financial instruments with the expectation that their value will change to generate a profit.

Forward Rate

The agreed-upon exchange rate for a forward contract, which is set at the inception of the contract.

Maturity Date

The date on which a forward contract is set to expire and the currency exchange is to occur.

Interest Rate Parity (IRP)

A theory that states the relationship between interest rates and currency values, indicating that the difference in interest rates between two countries should equal the forward premium.

Non-Deliverable Forward (NDF)

A type of forward contract where the currencies are not physically exchanged; instead, the cash value is settled in a convertible currency.

Premium

A situation in which the forward rate is greater than the spot rate, indicating an expected appreciation of the base currency.

Discount

A situation in which the forward rate is less than the spot rate, indicating an expected depreciation of the base currency.