CFM12130 - Understanding corporate finance: foreign exchange: managing exchange risk: currency derivatives

Currency derivatives

Large businesses often use derivatives to manage exchange risk. They may make forward purchases of currency, or make use of currency futures, options and swaps. CFM13000 explains more about how companies use these sorts of derivative.

The majority of companies that undertake transactions on the spot market, or who participate in the futures, options or swaps markets, do so either because they need foreign currency for their trade, or because they want to hedge exchange risks. But companies may also buy and sell currencies or derivative contracts speculatively - they hope to make a profit from anticipated changes in exchange rates.

The biggest speculators are clearing and investment banks, many of which engage in proprietary trading using their own (as opposed to their customers’) money. But other large multinational groups may engage in activity that might be seen as somewhat speculative. Indeed, the treasury departments of the largest groups may at times adopted strategies with similarities to those of banks. Normally, however, one would expect the activities of group treasury to be limited by policies designed to avoid the taking of risks outside a group’s core competences.