Question

1. Discuss various types of derivatives contracts: options, futures, and forward contracts.

2. How might derivative contracts come into play when purchasing products overseas and having them shipped to your business in the U.S. and vice verse?

Answer 1

1. a)Option gives the right and not obligation to buy or sell an asset at a particular strike price ( the agreed price at which transaction would take place). Options are of 2 types call and put option. Call option gives the right to buy an underlying asset at strike price and put option give the right to sell the underlying asset at strike price.

b) Futures provide an obligation for buyer or seller to purchase or sell an asset at a future date for predetermined price. These are highly standardized and are traded on exchange. Commodities like corns, wheat, etc. and currency can be hedged by futures contracts.

c) Forward unlike futures is non-standardized contract but can be customized. It is traded over the counter. It provides an option to buy or sell a commodity or currency at fixed price in a future date. It helps in hedging currency, price of commodity and interest rate risk.

2) Derivative contracts help in hedging currency risk while purchasing products or selling products abroad. By entering into derivative contract the transaction can occur at fixed predetermined price at a future time and this helps in overcoming currency exchange risk.


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