Currency Options in Function of Currency Risk Hedging and Speculating

Abstract

Due to current monetary policy of National Bank of Serbia which is focused on targeting the inflation rate, and therefore the introduction of a flexible foreign exchange rate policy which includes foreign exchange rate fluctuations, there is need for transactions performed in foreign currencies to be ensured from unpredictability of foreign exchange rate movements. This is related not only to transactions but also to property that is denominated in foreign currency. Serbia is a country in the advanced transition becoming more open to other markets, which requires the use of all more sophisticated financial instruments in business to reduce the risk due to the unpredictability of market. Mechanism that is used in the function of reducing the risk of foreign exchange rate in the financial markets of developed countries is currency hedging. A currency derivative is the contract whose price is partially derived from the value of the underlying currency that is represents. Some individuals, corporations and financial institutions take position in currency derivatives to hedge or speculate on future foreign exchange rate movements. Currency options provide the right to purchase or sell currencies at specified prices. The specific objective of this text is to explain how currency option contracts are used to speculate or hedge based on anticipated foreign exchange rate movement.