Discuss the Role of Exchange Traded Currency Options in Risk Management - Essay Example

Over the counter (OTC) transactions are primarily utilized in currency options trade. Leverage is integral to exchange traded currency options. In this regard, returns associated with the resultant transactions are massive. On the same note, such transactions come with a downside of risks. Combining traded currency options with concurrent forex pair enhances locking in of profits. As a result, risks are minimized. Therefore, the role of exchange traded currency options in the management of risks can be evaluated on the degree with which they manage to reduce risks in the underlying transactions and investment activities in the options market.

In the view of risk management by the use of exchange traded currency options, foreign exchange rates for different currencies around the world becomes essential to consider. On the same note, it is important to note that different countries have adopted different exchange rate regimes in regard to world currencies. Fixed, flexible or both exchange rate regimes are used by countries around the world. . Individuals and investors are termed as risk averse, risk takers or risk neutral. Given this three distinct behaviours, the decision rules taken under each of the three factors depict the role of exchange traded currency options.

Literature Review Currency options are hedged to accomplish various desired outcomes that are predetermined by the individual or the company that engages in currency options transactions. The roles of exchange traded currency options in managing risks can be evaluated from two different perspectives. One, prices and rates of exchange in the option market must be assessed for their characteristic risk magnitude. Two, the marginal utility of the individual, investor or the investing company must be assessed for its relevancy in the context of exchange traded currency options.

Holton (2003, p. 132) notes that risks that pertain to prices can neither be hedged nor insured. Risks that pertain to exchange rates in the foreign exchange market however, can be hedged. This is done through continued exchange of currencies that can be divided into simpler units that can continuously be handled. In other words, calls and puts therefore become essential in evaluating risk management in the light of exchange traded currency options. Risks associated with foreign exchange dealings are more or less business risks as Lam (2003) notes.

Numerous international corporations face unaccountable business risks that do not threaten their daily business aspects, but also the long term operations and performance. The management is accountable for overseeing financial stability. In the light currency options, multinational corporations account for risky business circumstances by engaging in international transactions especially those that involve foreign