future

A currency future, also FX future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. Typically, one of the currencies is the US dollar. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange markets. The trade unit of each contract is then a certain amount of other currency, for instance €125,000. Most contracts have physical delivery, so for those held at the end of the last trading day, actual payments are made in each currency. However, most contracts are closed out before that. Investors can close out the contract at any time prior to the contract's delivery date.

The pricing of a currency futures contract is completely determined by the prevailing spot rate and interest rates. Otherwise, investors would be able to arbitrage the difference between the futures and spot prices.

The futures price is given by:

where:

F = futures price
S = spot price
rT = interest rate of the term currency
rB = interest rate of the base currency
T = tenor (calculated according to the appropriate day count convention)
[edit] Hedging
Investors use these futures contracts to hedge against foreign exchange risk. If an investor will receive a cashflow denominated in a foreign currency on some future date, that investor can lock in the current exchange rate by entering into an offsetting currency futures position that expires on the date of the cashflow.

For example, Jane is a US-based investor who will receive €1,000,000 on December 1. The current exchange rate implied by the futures is $1.2/€. She can lock in this exchange rate by selling €1,000,000 worth of futures contracts expiring on December 1. That way, she is guaranteed an exchange rate of $1.2/€ regardless of exchange rate fluctuations in the meantime.

Speculation
Currency futures can also be used to speculate and, by incurring a risk, attempt to profit from rising or falling exchange rates.

For example, Peter buys 10 September CME Euro FX Futures, at $1.2713/€. At the end of the day, the futures close at $1.2784/€. The change in price is $0.0071/€. As each contract is over €125,000, and he has 10 contracts, his profit is $8,875. As with any future, this is paid to him immediately. Edit: Quoting for FX Futures at CME is in €/$ not $/€!

More generally, each change of $0.0001/€ (the minimum Commodity tick size), is a profit or loss of $12.50 per contract.}}
A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk, for example currency exposure risk (e.g., forward contracts on USD or EUR) or commodity prices (e.g., forward contracts on oil).

One party agrees (obligated) to sell, the other to buy, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collateralized, exchange of margin will take place according to a pre-agreed rule or schedule. Otherwise no asset of any kind actually changes hands, until the maturity of the contract.

The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands (on the spot date, usually two business days). The difference between the spot and the forward price is the forward premium or forward discount.

A standardized forward contract that is traded on an exchange is called a futures contract.
Derivatives are financial instruments whose value is derived from the value of something else. The main types of derivatives are futures, forwards, options, and swaps.

The main use of derivatives is to reduce risk for one party. The diverse range of potential underlying assets and pay-off alternatives leads to a huge range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) — see inflation derivatives — or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the pay-offs.

Portfolio
It should be understood that derivatives themselves are not to be considered investments since they are not an asset class. They simply derive their values from assets such as bonds, equities, currencies, etc. and are used to either hedge those assets or improve the returns on those assets.

Cash flow
The payments between the parties may be determined by:

the price of some other, independently traded asset in the future (e.g., a common stock);
the level of an independently determined index (e.g., a stock market index or heating-degree-days);
the occurrence of some well-specified event (e.g., a company defaulting);
an interest rate;
an exchange rate;
or some other factor.
Some derivatives are the right to buy or sell the underlying security or commodity at some point in the future for a predetermined price. If the price of the underlying security or commodity moves into the right direction, the owner of the derivative makes money; otherwise, they lose money or the derivative becomes worthless. Depending on the terms of the contract, the potential gain or loss on a derivative can be much higher than if they had traded the underlying security or commodity directly.

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