Key Terms

American option
an option that the holder can exercise at any time up to and including the exercise date

appreciate
when one unit of a currency will purchase more of a foreign currency than it did previously

call option
an option that gives the owner the right, but not the obligation, to buy the underlying asset at a specified price on some future date

depreciate
when one unit of a currency will purchase less of a foreign currency than it did previously

derivative
a security that derives its value from another asset

duration
a measure of interest rate risk

economic risk
the risk that a change in exchange rates will impact the number of customers a business has or its sales

European option
an option that the holder can exercise only on the expiration date

exchange rate
the price of one currency in terms of another currency

exercise price (strike price)
the price the option holder pays for the underlying asset when exercising an option

exercising
choosing to purchase or sell the asset underlying a held option according to the terms of the option contract

expiration date
the date an option contract expires

forward contract
a contractual agreement between two parties to exchange a specified amount of assets on a specified future date

futures contract
a standardized contract to trade an asset on some future date at a price locked in today

hedging
taking an action to reduce exposure to a risk

margin
the collateral that must be posted to guarantee that a trader will honor a futures contract

marking to market
a procedure by which cash flows are exchanged daily for a futures contract, rather than at the end of the contract

natural hedge
when a company offsets the risk that something will decrease in value by having a company activity that would increase in value at the same time

option
an agreement that gives the owner the right, but not the obligation, to purchase or sell an asset at a specified price on some future date

option writer
seller of a call or put option

premium
the price a buyer of an option pays for the option contract

put option
an option that gives the owner the right, but not the obligation, to sell the underlying asset at a specified price on some future date

speculating
attempting to profit by betting on the uncertain future, knowing that a risk of loss is involved
spot rate

the current market exchange rate
strike price (exercise price)
the price an option holder pays for the underlying asset when exercising the option

swap
an agreement between two parties to exchange something, such as their obligations to make specified payment streams

transaction risk
the risk that a change in exchange rates will impact the value of a business’s expected receipts or expenses

translation risk
the risk that a change in exchange rates will impact the value of items on a company’s financial statements

vertical integration
the merger of a company with its supplier