Derivatives Assignment Example | Topics and Well Written Essays - 750 words

Derivatives - Assignment Example With the help of forward contracts two parties can fix the exchange rate between them for the future transactions (Federal Reserve Bank, 2010). This simple kind of agreement can eliminate exchange rate risks significantly. As the exchange rate is already decided between the two parties, transaction will take place in that rate only. With the help of future contracts also foreign exchange risks can be hedged. This derivative is also somewhat similar with forward contract. But liquidity of this contract is high as it is generally being traded on organized markets (Federal Reserve Bank, 2013). With the help of this contract parties are to buy or to sell a specific currency at a future date, at a particular rate of exchange which is fixed and agreed upon by the two parties in present. Option is also a derivative through which foreign exchange risk can be hedged. With the help of this contract interests of the buyers and sellers are taken care of significantly (Kotze, 2011). According to this contract, buyers have the right but do not have any obligation to buy or sell a particular currency at a particular exchange rate. But sellers have obligations if the buyers exercise their rights. In this way with the help of options foreign currency risks can be hedged. Derivatives are generally used for hedging against foreign exchange currency risks. There are several examples where derivatives have caused significant losses for the company. MG was significantly impacted by the usage of the derivatives. Using derivatives were integral parts of the company’s marketing and hedging programs. In 1993 the organization incurred huge losses related with the derivatives (Nihalani, 2011). The losses were over US $ 1 billion. At that point of time it was the largest derivative loss by any company. The organization was on the verge of bankruptcy. The bank was forced to seek for a rescue package of $1.9 billion from a