What are Currency Futures?

A currency future contract is a contract that allows market participants to trade the underlying exchange rate for a period of time in the future. Currency futures are agreements between two counterparties where one counterparty longs the underlying exchange rate and the other shorts the underlying exchange rate on a specified future date. The underlying instrument of a currency future contract is the rate of exchange between one unit of foreign currency and the South African Rand. Currency futures are contracts that allow participants to take a view on the movement of the exchange rate as well as hedge against currency risk. Currency futures will be used as a trading, speculating and hedging tool by all interested participants.

Currency Risk

Currency risk or foreign exchange exposure is the exposure to an unfavourable movement in a currency or exchange rate. Investors importing goods from abroad or exporting goods abroad and transacting in foreign currency or the investor’s home currency are susceptible to changes in the exchange rate and, as a result, this changes the expected income. Individuals traveling overseas are also subject to exchange rate fluctuations and the weakening of their home currency to the foreign currency in the country that they are visiting.

Theoretically, currency risk is the combination of transaction, translation, economic and political exposure.Transaction exposure refers to cash flow exposure.

This is the currency risk a firm has to face when expecting to receive or pay a fixed amount of foreign currency in the future as these cash flows will be revalued in the case of a change in exchange rates.Translation exposure, also known as accounting exposure, is the degree to which exchange rate fluctuations affect a multinational parent company's book value when financial statements of the company’s global operations are consolidated and stated in the parent company's home currency.Economic exposure, also called operating exposure, measures the change in a company’s expected operating cash flows as well as the market value of the company due to a change in exchange rates. Economic exposure can affect either the company’s profitability or market share by hampering its competitive position in a particular market.Political exposure refers to changes in an exchange rate value caused by political actions undertaken by a country’s government. Examples of political risk include government imposing changes in tax laws and exchange control regulations, both of which will have an effect on the exchange rate of that country’s currency compared to other currencies