• Simple financial instruments used to reduce exporting risks due to currency fluctuations.

Three main derivatives include:

  • Forward exchange contract: a contract to exchange one currency for another currency at an agreed exchange rate on a future date, usually after a period of 30, 90 or 180 days.
  • Options contract: gives the buyer (option holder) the right, but not the obligation, to buy or sell foreign currency at some time in the future. Option holders are protected from unfavourable exchange rate fluctuations yet maintain the opportunity for gain should exchange rate movements be favourable.
  • Swap contract: agreement to exchange currency in the spot market within agreement to reverse the transaction in the future. Allows businesses to alter its exposure to exchange rate fluctuations without discarding original transaction. Financial instruments to support business’s hedging activities.

Extract from Business Studies Stage 6 Syllabus. © 2010 Board of Studies NSW.