Foreign Exchange Markets

Forward, Futures and Options Foreign Currency Markets Review of Foreign Exchange Markets Assessment of Foreign exchange Markets Forward, Futures and Options Foreign Currency Markets Forward currency market entails an agreement for sale or purchase of foreign currency at a set price and at a particular date. In this agreement, final cash settlements are undertaken only on the set date where the contracting parties realize their gain or loss.

Forward currency contract is a private agreement that is not undertaken over -- the counter making the contract more flexible and less standardized compared to futures contract (Eiteman, Stonehill, & Moffett, 2001). Futures contract is a standardized agreement trades on exchanges or in over-the-counter markets. The agreement is between the seller and the buyer where the seller is referred to as the one taking a short position and the seller is referred to as the one taking the long positing.

For the agreement to be arrived at, a specification of underlying exchange is some detail is required. A statement of the size of the contract, the value of the exchange, the delivery location and the expiry date must also be given. To reflect the changes in the settlement market a futures contract is highlighted in the market on daily basis (Eiteman et al., 2001).

An option is a contract that extends the parties right to sell or buy specified value of a currency (asset) at a specified price at some time in the future. This is however, not an enforcing obligation upon the parties since they have the derogative to act upon the option if it to their advantage. Given the derogative to act when it is advantageous to them the option has a premium payable at the inception of the contract.

This aspect makes options contact significantly different from the forward or futures contract. The buyer has the "call option" giving them the right to buy currency while, the seller has the "put option" giving him/her the derogative to sell currency (Copeland, 2008). Arbitrage problems in international finance Forward contract shortcomings sets in where it is difficult to get a counter party willing to fix future rate for the time and amount in question.

As a tool to mitigate in exchange rate risk management, forward contract have no formal trading facility that can support management of risk associated with currency trading. In the absence of willing party to undertake possible loss or gain makes it difficult to relay on forward contract to safe guard international trading (Copeland, 2008). Considering a company undertakes to construct a road in foreign country at a set future date on an agreed amount.

The company enters into contract with a local bank to fix the current exchange rate in line with the payment date for the construction company. The bank on the other hand may have to find a counter party. This would be a party willing to hedge against appreciation of the foreign country's currency or one wishing to speculate an upward trend of the foreign currency (Eiteman et al., 2001). Failure to get either of the counter parties the bank undertakes to bear the risk its self.

In the case of forward contracts in currency market, the inadequacy of the number of willing counter parties makes arbitrage in international financial transaction a difficulty. Futures foreign currency markets come in to resolve the inadequacy that forward market inherently present. Futures contract unlike the forward contract has standardizing features entailing expiry date, contract size, its month, price limit and position limit. The positing limit entail the number of contract an individual can buy or sell. The price limit indicates the maximum daily price alterations.

Since a futures contract is assessed on a daily basis, the contracting party is updated whenever significant changes occur in their account that requires them to pay additional amount (Hull, 2006). The standardization features introduce hedging imperfections since some contractual needs of the futures contract may not be met. It may be difficult to and some cases impractical to meet the standardization feature of matching transaction in order to safe guard against changes in the exchange rates (Copeland, 2008).

In the futures contract, international finances involving bidding for contracts may turn out to be unsuccessful owing to the speculative positing taking up by interested parties. Some part of the spot transactions may go unhedged since overhedging is advised against. Futures contract have an implication of overwhelming cash flow burden given that a party is required to pay an initial deposit and subsequently meet the variation margins on a daily basis (Hull, 2006). As an international finance tool to safe guard on changes in interest rates, above shortcomings make it undesirable.

Option currency market allows for flexibility and price hedging otherwise absent in the other two contracts. In the case of the constructor.