Futures and options are both derivative instruments, which means they derive their value from an underlying asset or instrument. Both futures and options have their own advantages and disadvantages. One of the advantages of options is obvious. An option contract provides the contract buyer the right, but not the obligation, to buy or sell an asset or financial instrument at a fixed price on or before a predetermined future month. That means that the maximum risk to the buyer of an option is limited to the premium paid. A disadvantage of an option contract is that it may expire worthless. This risk increases the greater the extent to which the option is out of the money and the shorter the time until expiration. But futures have some significant advantages over options. A futures contract is a binding agreement between a buyer and seller to buy or sell an asset or financial instrument at a fixed price at a predetermined future month. The disadvantages are: they come with a credit risk, risk of default is high, and they can be hard to cancel. “when China’s stock markets were at a relatively high level. The authorities hoped that the bullish markets would provide a buffer for the introduction of the futures contracts and also that the futures could help “smooth out the market fluctuations” of the underlying spot market” (Fung, Hung-Gay; Liu, Qingfeng Wilson. September-October 2013). What are the costs of each alternative? Forward contracts do not cost any money upfront. However, if a seller hedges in the price by locking in a forward if a currency depreciates, they face many costs if the currency appreciates.The cost for an option contract is called a premium. It is a deposit paid for a future purchase. If, however that contract expires before it is received, the premium is worthless. When is one alternative preferred over the other? Option contracts are becoming more popular over forward contracts because they are less risky, it gives you the right but not the obligation to buy or sell assets, and they are also more flexible than forward contracts. References Fung, Hung-Gay; Liu, Qingfeng Wilson. September-October 2013, v. 46, iss. 5, pp. 36-49. What Makes a Successful Futures Contract? Case of China\’s Stock Index Futures. Retrieved from Ashford Library: “Transaction exposure to currency risk refers to potential changes in the value of future cash flows (committed or anticipated) as a result of unexpected changes in exchange rates” (Hagelin, Niclas. January 2003). For me transaction exposure would be most important. The reason is you’re actually dealing with cash flow and cash flow as we all know is very important. If there is a change in the market, be it good or bad it changes the cash flow. When it comes to translation exposure, it deals only with the sale of assets and this includes any liquidation of assets as well. One thing I would certainly do here is still pick a good time to sell my assets at a good time to maximize my gains.What are the advantages and disadvantages of the common methods for controlling translation exposure? The common methods for controlling translation exposure are: 1) a balance sheet hedge, and 2) a derivatives hedge. The advantage of a balance sheet hedge is that it eliminates the mismatch between assets and liabilities. The disadvantage however, is that it may create transaction exposure. The advantage of a derivatives hedge is that it uses forward contracts, therefore, any transaction will be taking place in the future, giving the investor or trader time to manage their account. The disadvantage is that it involves a lot of speculation about foreign exchange rate changes; which without the knowledge could result in a loss. References Hagelin, Niclas. January 2003, v. 13, iss. 1, pp. 55-69. Why Firms Hedge with Currency Derivatives: An Examination of Transaction and Translation Exposure. Retrieved from Ashford Library:
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