Answer to Question #283420 in Macroeconomics for Comfort

Question

QUESTION SEVENTEEN

There are different financial instruments to hedge the exchange rate risk. The main text mentions three

financial instruments: forwards, swaps and options. Explain what these instruments entail and which

of them is most fit to secure that at a specific time a certain amount of foreign currency can be

exchanged to local currency against a predetermined exchange rate. [15 marks]

Answer 1

A call option gives the buyer the right (not the obligation) to buy an asset at a set price on or before a set date.

A forward contract is an obligation to buy or sell an asset.

A swap is an agreement between two parties to exchange sequences of cash flows for a set period of time.