Question

Explain how currency futures could be used to hedge your business in Mexico. Explain how currency options could be used to hedge your business in Mexico.

Answer 1

A currency future is a future contract to exchange one currency for another at a specified date in the future at a specified price decided at the initiation of the contract. So, in this particular case, lets say an Indian company has operations in Mexico wants to hedge its currency risk of appreciating Mexican Peso against Indian Rupee. As, the operations are in Mexico and the comapny is Indian, so they wants to convert the money obtained from Mexico to Indian Rupee and if Mexican Pero appreciates, so the company will get less Indian Rupee. So, the comapny will get into currency future contact to hedge this fluctuation in exchange rates.

A currency option is a contract that gives the buyer the right (not the obligation) to buy or sell the underlying (currency in this case) at a specified exchange rate and at specied date. Lets take the same example as above, an Indian company has operations in Mexico wants to hedge its currency risk of appreciating Mexican Peso against Indian Rupee. As, the operations are in Mexico and the comapny is Indian, so they wants to convert the money obtained from Mexico to Indian Rupee and if Mexican Pero appreciates, so the company will get less Indian Rupee. So, the comapny will get into currency options contact to hedge this fluctuation in exchange rates. So, if mexican peso appreciates, the company will avail the option and if mexican peso appreciates, the company will not excercise the option. In option, company has to pay some premium to get into a contract.