Financial Derivative
Apart from the traditional role of buying and selling foreign currencies on spot and forward basis, foreign exchange markets offer also other instruments like options, futures and swaps. Along with forward contracts, these new instruments are called financials derivatives as their value is derived from the value of some other underlying financial contract or asset. Of these new instruments, currencies futures and options are designed basically to afford protection from exchange risk. Swaps and interest rate futures are used for protection against interest rate risk.
Derivative: Currency futures
A future contract is a form of forward contract in that it conveys the right to purchase or sell a specified quantity of a foreign currency at a fixed exchange rate on a specified future date. It is a financial derivative. Whereas in a forward contract the quantum of foreign currency and the due date are determined by the customer, in a futures contract these are standardized. While forward contract can be entered into by a person will any bank at any place, the futures contract can be entered into only with the financial futures exchange. Thus a futures contract may be deemed as an agreement entered into with the specified futures exchange to buy or sell a standard amount of foreign currency at a specified price for delivery on a specified future date. Both derivative have some deference in-between.
