大学ESSAY范例

Essay topic: why companies use currency derivatives?

Currency derivative can be defined as a contract or financial agreement to exchange two currencies at a given rate or a contract whose value is derived from the rate of exchange of two currencies on spot (Shoup, 1998). Currency derivatives are developed and adopted to implement a strategy known as hedging, in which an organisation acquires a contract in order to offset an expected drop or rise in value of a position or future cash flow (Belk & Edelshain, 1997). This essay will outline the incentives and rationales behind an organisation that uses currency derivatives.

There are three types of currency derivatives used in hedging, future contracts, forward contracts and options, although swaps are also commonly considered as a currency derivative (Shoup, 2008). These instruments are derived from a spot rate, which is the price of the ―underlying currency‖ (Eiteman, Stonehill & Moffett, 2009). Options are normally more costly than future contracts and forward contracts, because options are rights rather than obligations to buy or sell a currency (gives buyers the right not to exercise the contract if the spot rate movement is not favourable) (Belk & Edelshain, 1997). Research in New Zealand indicates that 70% of currency derivative users used forwards, which are most prevalent currency derivative instrument (Chan, Gan & McGraw, 2003). This is possibly because forwards are easy to manage and understand and can be used in frequent and uncertain transactions. Over-the-counter options are the second most popular instrument by NZ users of currency derivatives (40%), as options give users more flexibility (selling or buying a currency only when the firm can earn profit) (Chan et al, 2003).

There are basically two purposes currency derivatives serve when they are used. The first is to speculate on the favourable currency movement and earn profit from currency fluctuation (Eiteman et al, 2009). This normally requires users to have profound knowledge of currency movements and accurate expectation. However, the benefit is that participants can earn profits. A good example is that international investors are scheduled to create a dairy product derivative in New

Zealand in June. Although not qualified as a currency derivative in technical terms, this derivative bears resemblance to currency derivatives essentially (Rutherford, 2010). For example, if a buyer believes that the future rate is lower than the spot rate at a given date, he/she can enter a future contract to buy a dairy product at that date and then sell it immediately in the spot market therefore earning the differentials. The currency derivative operates in the same principle.

In a study of the US’s fortune 500 firms, Geczy, Minton & Schrand (1997) found that hedging is used by organisations normally for risk minimisation rather than speculation. A potential explanation is that it is a complex job to predict currency movements; the expense of analysing currency movements which cannot be justified by income (Maurer & Valiani, 2007). Let alone, exposure to currency risk can be compounded by economic exposure. Organisations are more likely to perceive currency fluctuation as a threat rather than an opportunity. This accounts for the fact that when an organisation suspects that a financial distress is imminent, it is very likely to use a currency derivative while this threat is remote, it will not use a currency derivative (Hagelin, 2003). In New Zealand, Air NZ is a successful firm which has used foreign exchange derivative. As an organisation whose income is heavily exposed to exchange rate changes, Air NZ has enriched experience in the use of hedging. In 2009, the organisation earned a total of $ 272 million dollars from hedging, compared to its total net profit of $ 118 million (McNabb, 2009). Although Air NZ claimed that the hedging is not in speculative nature, it is clear that the organisation’s successful prediction over the appreciation of New Zealand dollars allowed it to profit from boosting income at a relatively low forward contract rate (compared to the spot rate).

The second is to combat the unfavourable currency movement by reducing the negative impact of currency exposure (Eiteman et al, 2009). This can be understood by the fact that for an organisation who is involved in international business, exposure to currency fluctuation accounts for the dramatic variance of the organisation’s income and expenses(Cusatis & Thomas, 2005). It is found that forward contracts are normally used to eliminate the variance involved in