Reference no: EM13208442

Discuss the following topic: "Should speculators use currency futures or options?" Many multinational firms use currency derivatives for hedging purposes. To reduce their exposure to foreign currencies, due to investment or trading in foreign countries many multinational firms use either currency futures, options, or both. However, many investors in the currency derivatives are speculators. These investors are trying to capitalize on the fluctuations of currency markets. These investors prefer the currency derivative because it allows them to take a large position with small amount of investment. Therefore, through the currency derivatives they can magnify their profit. But at the same time, if they misjudged the market, they can pay dearly. The issue here is whether these speculators should use futures or options when speculating on the directions currency prices are moving.

Instructions:

1- To read the point and counter-point of this argument and express your own opinion on this topic :

Point: Yes 

Speculators should use currency futures because they can avoid a substantial premium. To the extent that they are willing to speculate, they must have confidence in their expectations. If they have sufficient confidence in their expectations, they should bet on their expectations without having to pay a large premium to cover themselves if they are wrong. If they do not have confidence in their expectations, they should not speculate at all.

Counter-point: No 

Speculators should use currency option to fit the degree of their confidence. For example, if they are very confident that a currency will appreciate substantially, but want to limit their investment, they can buy deep out-of- the-money options. These options have a high exercise price but a low premium, and therefore require a small investment. Alternatively, they can buy options that have a lower exercise price (higher premium), which will likely generate a greater return if the currency appreciates. Speculation involves risk. Speculators must recognize that their expectations may be wrong. While options require a premium, the premium is worthwhile to limit the potential downside risk. Options enable speculators to select the degree of downside risk that they are willing to tolerate.