Off Balance Sheet Instruments

¶ … Balance Sheet Instruments

Describe how each of the "off-balance sheet instruments" (swaps, forwards, futures, options) helps in mitigating foreign exchange risk.

A swap is the exchange of one security for another security because investment climate has changed. Recently, swaps have grown to include currency swaps and interest rates swaps, to take account of changing exchange rates and thus mitigating risk. ("Swap," Investopedia) Similarly, in currency forward contracts, the contract holders are obligated to buy or sell the currency at a specified price, at a specified quantity, and on a specified future date. These contracts cannot be transferred and thus prevents a potential loss, should exchange rates change and render the contract less profitable than originally intended for one of the parties involved. ("Currency Forward," Investopedia) Futures are financial contracts that obligate the buyer (seller) to purchase (or sell and deliver) financial instruments or physical commodities at a future date, regardless of currency exchange. Thus these contracts protect the seller should the buyer wish to pull out of the contract, if the risks prove to great. Options provide the holder the right to buy or sell the underlying asset at expiration, and are thus more protective of the seller, while futures contracts holders are obligated to fulfill the terms of their contract. ("Futures," Investopedia)