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An Overview of Foreign Exchange Derivatives

In international finance, derivative instruments imply contracts based on which you can purchase or sell currency at a future date. The three major types of foreign exchange (FX) derivatives: forward contracts, futures contracts, and options. They have important differences, which changes their attractiveness to a specific FX market participant.

FX derivatives are contracts to buy or sell foreign currencies at a future date. The table summarizes the relevant characteristics of three types of FX derivatives: forward contracts, futures contracts, and options. Because the types of FX derivatives closely correspond to the identity of the FX market participant, the table is based on the derivative type-market participant relationship.

An Overview of the Relevant FX Derivatives
Forward Contracts Future Contracts Options
Standardized regarding the amount of currency No Yes Yes
Obligation to engage in the transaction on the specified day Yes Yes No, but premium must be paid
Traded No CME Group GLOBEX
OTC
CME Group
GLOBEX
ISE
OTC
Useful for MNCs Yes Yes Yes
Useful for speculators No Yes Yes

CME Group: the leading derivative exchange formed by the (2007) merger of the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange (CBOT); GLOBEX: an international, automated trading platform for futures and options at CME; ISE: International Security Exchange, a subsidiary of EUREX, a European derivative exchange; OTC: over-the-counter.

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Derivation of the Interest Rate Parity (IRP)
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