Briefing

Date: 2015-10-07; view: 565.

The forex market is one of the most popular markets for speculation due to its enormous size, liquidity and tendency for currencies to move in strong trends.An enticing aspect of trading currencies is the high degree of leverage available. FX allows positions to be leveragred up to 100:1. Without proper risk management this high degree of leverage can lead to enormous swings between profit and loss. Knowing that even seasoned traders suffer losses, speculation in the forex market should only be conducted with risk capital funds that if lost will not significantly affect one's personal financial well being.

Companies trading internationally are exposed considerable foreign exchange risk. If, for example, a French company knows that it will need $2 million in three months' time to pay for imports from the USA, it can buy the dollars forward, i.e. at a rate specified now, thus eliminating the risk of an adverse movement in the exchange rate between the EUR and the US dollar. Unfortunately, buying dollars forward also eliminates the possibility of a favorable movement in exchange rates. Alternatively, the company could wait three months and then buy the dollars at the spot rate, i.e. the rate charged then for funds to be delivered two working days after the transaction. This way the company may get a better exchange rate but it also runs a risk, since the rate could be worse. Essentially, either course of action involves a calculated gamble on exchange rates.

To meet this situation, some banks developed and began to offer currency options in the early 1980s. Transactions in options carry a high degree of risk. Purchasers and sellers of options should familiarize themselves with the type of option (i.e. put or call) which they contemplate trading and the associated risk. Under the currency option, the customer pays a premium which gives them the right to demand purchase or sale of a specified currency at an agreed exchange rate up to an agreed date, but no obligation to do so. After the customer pays the premium, the bank sends out confirmation of the deal. If the exchange rate in three months' time, or whenever the expiration date is, is better than the one the customer has agreed on, they do not use the option, and instead deal at the market rate when they need to. Their cost has only been the premium for the option. Alternatively, if the rate is worse than the one they have agreed upon, they exercise the option, and thus suffer no loss due to the fall in exchange rates. The customer may exercise the option at any time up to and including the expiration date, for value spot. This, then, is the basic idea of the currency option.

Options on currencies can offer a wide and diverse range of potentially attractive trading opportunities. However, option trading is a speculative endeavor and should be treated as such. Even though the purchase of options on currencies involves a limited risk (losses are limited to the costs of purchasing the option), it is possible to lose your entire investment in a short period of time. And for traders who sell rather than buy options, there is no limit at all to the size of potential losses.

· Read the briefing

· Check your comprehension and answer the following guestions:

1. Why is the aspect of trading currencies through the operations of foreign exchange market so enticing?

2. Why does foreign exchange risk management play an enormous role in forex market operations?

3. What are certain disadvantages of forward transactions in the Interbank market?

4. What should option holders bear in mind dealing with currency options trading?

5. What dangers do foreign currency options operations entail being actually a speculative business?

· Say if the statements are true or false.

1. The forex market hardly provides foreign exchange for the purpose of speculation.

2. This market of exchange has had more daily volume than any other in the world and carries no risk.

3. Actually purchasing dollars forward expels the possibility of a favourable movement in exchange rates.

4. Only experienced forex traders are sure to avoid losses involved in the foreign exchange operations.

5. Buying dollars at the spot rate in three months' time may let the company get a better exchange rate since the rate can not be worse.

6. Currency options business has been developed to offer a wider range of currency trading opportunities.

7. An option gives the buyer the right to buy or sell a particular currency at a stated price at any time prior a specified date and certain commitments to do so.

8. The option is not exercised by the option holder at any time up to and including the expiration date, for value spot.

9. Options trading losses are limited to the costs of buying the option.

10. Both option buyers and option sellers are not secure from potential financial losses.