Why Companies Invest In The Forex

For some time multinational corporations have hedged foreign exchange risks with forward or futures contracts

. Companies are now able to buy or sell a given amount of foreign currency at a specified exchange rate at some future date with these contracts. Having these Forward and futures contracts will grant one party the right and obligation to pay during maturity. Not knowing how the market will move or change there is a big fear of incurring losses. There are lesser losses on option then the real premium paid.

It is good to note that in foreign exchange options holders are able to purchase or sell a designated quantity of foreign currency at a specified price or exchange rate up to a specified date. With the call option you will have the right to buy the currency by exercising the option. You have to make sure that the expiration or maturity date of the option has not passes yet so it will be valid. An exercise price is the exchange rate at which the specified foreign currency can be bought or sold.

Holders with the American option will be able to exercise it at any time up to and including its expiration date. In the European option it can be exercised only at the expiration date. Option writers grant the right to sell and buy currency while if you buy these rights you are the option buyers. It is best to note that right to buy foreign currency or call option is also the right to sell domestic currency or put option.

The buyer is entitles to pay the seller an option price before they can use the call option. Payment will signify that sellers must fulfill the obligations specified in the contract at the request of the buyer. In a call option when the expiry date comes, the value of a call option is determined by the spot exchange rate and the exercise price.

Many traders are known to say the option is said to be in the money when the spot price is higher then the exercise price. Profits will come when the holder is able to exercise it at expiration and thereby purchases the sterling at a cheaper price as agreed upon in the option contract instead of in the spot market at a more expensive exchange rate. Normally the option is said to be at the money when the spot and exercise is at par.

There are profits once you are Buying at the exercise price and selling at a higher spot price. The holder is able to break even when the spot price exceeds the exercise price only by an amount equal to the premium paid.

Each time buyers and sellers of call options will earn opposite payoffs. All a seller can earn is the premium that he was paid and the gains of the buyer are none of his business. If the option expires unexercised, the seller profits by the full amount of the premium. Even in other options such as buying and selling a put the rules are the same.

Each buyer has the right to sell a currency at a fixed price on some future date without the obligation to sell, the buyer can have the chance to make unlimited profits should the underlying currency strengthen and limit loss in the buying a put option. What is meant by the break-even point is that pound sterling has appreciated sufficiently enough to compensate for the initial premium paid out. Selling a put will mean the option writer earns the premium, but accepts substantial risk should the pound sterling depreciate.

by: Wilcoxrichard

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