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__________ is a standardized contract to exchange one currency for another at a specialdate in the future at a price (exchange rate) that is fixed on the purchase date.

__________ is a standardized contract to exchange one currency for another at a special date in the future at a price (exchange rate) that is fixed on the purchase date.

Looking for the answer to the question below related to Ratio Analysis ?

__________ is a standardized contract to exchange one currency for another at a special date in the future at a price (exchange rate) that is fixed on the purchase date.

 Options:

A. Futures Contract
B. Options Contract
C. Swaps
D. Forward contract

The Correct Answer Is:

  • A. Futures Contract

The correct answer is A. Futures Contract. A futures contract is a standardized contract to exchange one currency for another at a specific date in the future at a price (exchange rate) that is fixed on the purchase date. Let’s delve into why this answer is correct and why the other options are not applicable:

A. Futures Contract:

A futures contract is a standardized financial derivative traded on organized exchanges. It obligates the buyer to purchase and the seller to sell a specific amount of an underlying asset, such as a currency pair, at a predetermined price (the futures price or exchange rate) on a specified future date. The key features of futures contracts include:

1. Standardization:

Futures contracts are highly standardized in terms of contract size, maturity date, and the method of settlement. The standardized nature of these contracts ensures that all participants are trading the same instrument, making them fungible and easily transferable.

2. Exchange-Traded:

Futures contracts are traded on organized financial exchanges, providing transparency, liquidity, and a regulated trading environment. These exchanges establish and enforce the rules and specifications for each contract, reducing counterparty risk.

3. Fixed Exchange Rate:

The exchange rate specified in the futures contract is agreed upon when the contract is initiated. This means that the exchange rate is locked in, and both parties are obligated to exchange currencies at this rate on the contract’s expiration date.

4. Delivery or Cash Settlement:

Depending on the contract’s specifications, futures contracts can either result in the physical delivery of the underlying currencies or be cash-settled. Physical delivery involves the exchange of the actual currencies, while cash settlement involves settling the contract’s value in cash based on the difference between the futures price and the market price at expiration.

Now, let’s discuss why the other options are not correct:

B. Options Contract:

Options contracts provide the holder with the right but not the obligation to buy (call option) or sell (put option) a specific amount of a currency pair or another underlying asset at a predetermined price (strike price) on or before a specified expiration date. Options differ from futures contracts in that they offer the flexibility of choice; the holder can choose whether or not to exercise the option.

In contrast, futures contracts are binding and require the exchange of currencies at a fixed rate. While options may involve currencies, they do not meet the criteria of a “fixed exchange rate” as specified in the question.

C. Swaps:

Currency swaps are financial agreements between two parties to exchange one currency for another at an agreed-upon rate, with a simultaneous agreement to reverse the exchange at a later date. Currency swaps are often used to manage foreign exchange risk and facilitate international trade.

They do involve currency exchange, but they do not have a fixed exchange rate at the outset, which is a distinguishing characteristic of futures contracts. Instead, the exchange rate in a currency swap may vary over time, depending on market conditions.

D. Forward Contract:

Forward contracts are similar to futures contracts in that they involve an agreement to exchange one currency for another at a specified future date and rate. However, forward contracts are typically customized and not standardized like futures contracts. Parties in a forward contract can negotiate the contract’s terms, making them more flexible but less standardized.

Additionally, forward contracts are not traded on organized exchanges, which can result in less transparency and increased counterparty risk compared to futures contracts.

In conclusion, a futures contract is a standardized financial contract used to exchange one currency for another at a fixed exchange rate on a specific future date. While options, swaps, and forward contracts all involve currency exchange, they differ in terms of standardization, flexibility, and the presence of fixed exchange rates, making the futures contract the correct answer to the question.

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