• Forward Contracts. Foreign currency contracts are one of the most popular
forward futures. However, they are available only for major currencies. Currency
forward contracts in other currencies can be arranged with large banks in the
over-the-counter market. Unlike futures contracts, forward contracts are less
standardized, can be customized to meet the hedging needs of the buyer, and are
not marked-to-market daily.
• Options Contracts. Currency options contracts give an investor the right, but not
the obligation, to buy (call option) or sell (put option) a specified amount of
currency at a date in the future at a pre-determined price. Exhibit 14.3 • Payoffs
for Call and Put Options Contracts.
• Swap Contracts. As another way to hedge exchange rate movements, firms can
agree to swap currencies in the future at a previously agreed exchange rate.
Currency swaps can be established over a period of up to ten years. Some
exchanges offer currency swaps, which lower counterparty risk due to guaranteed
performance by the exchange. Currency swaps are often combined with interest
rate swaps, which are commonly known as plain vanilla currency swaps. Exhibit
14.4 • Vanilla Currency Swap. The firms seek loans from foreign banks because
they are able to secure credit with more favorable interest rates or other loan terms
from the foreign lender. Firms can use currency swaps to save on credit costs.
DISCUSSION STARTER: REALITY CHECK 2.
Assume that you are a manager for a U.S. company that is selling products to a Japanese
company that will pay you in yen. Do you have exchange rate risk? How could you hedge this
risk to protect your company?
IV. Financing International Trade and Investment. Firms finance their international
operations in a variety of ways.
• International Banking. Large, money center banks in different countries dominate
international banking. Large, wholesale payments by businesses, banks, and governments
are made via CHIPS in New York City for dollar payments. SWIFT provides secure
communications for contracts, invoices, and other trade documents that accompany cash
payments. A number of payment methods exist that differ in terms of their risk.