Currency Futures, Options and Swaps

A forward contract locks in a rate but also locks the company in: if the exchange rate moves in its favour, it cannot benefit. Other instruments differ in how much they bind the company, how they are traded and what they cost.

A currency future is a standardised contract traded on an exchange, settled daily through a margin account; a currency option gives the right, but not the obligation, to exchange at a set rate, so the company is protected against an adverse move yet can still gain from a favourable one, at the price of a premium; and a currency swap exchanges borrowing in one currency for borrowing in another, which converts a long-term foreign currency liability into a home-currency one.

These are derivatives: instruments whose value comes from an underlying exchange rate. This topic explains each (the terms, the steps in a hedge, a worked calculation), compares futures with forward contracts, and says how to choose between instruments, with worked examples. The next topic starts the study of interest rate risk.

The comparison of futures with forward contracts was part of November Diet, 2025, Question 4 (20 marks). Read forward contracts and money market hedges first.

Currency futures

A currency future is a contract to buy or sell a standard amount of a currency at a set price on a set future date. It is traded on an exchange, which stands between buyer and seller, so there is little counterparty risk. Terms:

• Contract size: the fixed amount of currency in one contract (for example $50,000). Tick and tick size: the smallest price movement.
• Futures price: the price agreed for delivery on the settlement date; contracts are available only for a limited number of currencies and dates.
• Margin: a deposit to cover potential losses. The initial margin is paid to open the position; each day the account is marked to market, gains are credited and losses debited; if the balance falls below the maintenance margin, the investor must pay variation margin to restore it.
• Basis = spot price − futures price. It narrows to zero at expiry; basis risk is the risk that it does not narrow as expected, leaving the hedge imperfect.

The steps in a futures hedge

1. Target: the home-currency outcome without a move in the rate.
2. Number of contracts = exposure ÷ contract size (converted to the contract currency); round to a whole number. A whole number is a perfect hedge; otherwise it is imperfect.
3. Buy or sell: a company that will pay foreign currency buys futures; one that will receive it sells.
4. Expiry: choose the contract expiring just after the transaction date.
5. Close out on the transaction date by reversing the position; the gain or loss adjusts the cash market result.

1. Contracts = 1,000,000 ÷ 50,000 = 20 (a perfect hedge), and the importer buys 20 September contracts.
2. In September the spot rate is ₦1,470 (the offer) and the futures price has risen to ₦1,468.
3. Futures gain.
   (1,468 − 1,415) × 50,000 × 20 = ₦53,000,000.

The importer pays 1,000,000 × 1,470 = ₦1,470,000,000 for the dollars, less the gain: ₦1,417,000,000, an effective rate of ₦1,417 per $, which is the opening futures price plus the basis at the end (1,415 + 2). If the exposure were $1,030,000, the contracts would be 20.6, rounded to 21 (or 20) and the hedge would be imperfect. A fall in the futures price of ₦4 on one day would cost 4 × 50,000 × 20 = ₦4,000,000 in variation margin that day.

Currency options

A currency option gives the holder the right but not the obligation to buy (a call) or sell (a put) a currency at a set strike (exercise) price on or before an expiry date. The buyer pays a premium whether or not the option is used. Options may be over the counter (tailor-made with a bank, flexible but with counterparty risk) or exchange traded (standard, transparent, less risk of default). The right instrument depends on the exposure:

• A company that will pay foreign currency buys a call on that currency (protection against it becoming dearer).
• A company that will receive foreign currency buys a put (protection against it becoming cheaper).

Steps: choose call or put; work out the naira result if the option is exercised; work out the result if it is not (at the spot rate); take the better; deduct the premium.

Example. A Nigerian exporter will receive $500,000 in three months and buys an over-the-counter put option on dollars with a strike of ₦1,380 and a premium of ₦12 per dollar, a total premium of 500,000 × 12 = ₦6,000,000.

• If the spot rate then is ₦1,300, the company exercises: 500,000 × 1,380 = ₦690,000,000, less the premium ₦6,000,000 = ₦684,000,000 (selling at spot would give only ₦650,000,000).
• If the spot rate is ₦1,450, it lets the option lapse and sells at spot: 500,000 × 1,450 = ₦725,000,000, less the premium = ₦719,000,000.

The option sets a floor of ₦684,000,000 (an effective rate of ₦1,368 per dollar) while leaving the gain if the dollar rises. A forward contract at ₦1,385 would give ₦692,500,000 with no premium, so the option is better than the forward only if the spot rate at expiry is above about 1,385 + 12 = ₦1,397. The price of the flexibility is the premium, which is paid at the start and is lost if the option is not needed.

Currency swaps

A currency swap is an agreement between two parties to exchange principal and interest in two different currencies. It differs from an interest rate swap (same currency) in that the interest may be fixed against fixed. There is an actual exchange of principal at the end (and sometimes at the start) at a rate agreed at the start.

Swaps are used by borrowers who can borrow cheaply at home or in one currency but need another, and for long-term hedging of foreign currency debt, where forwards are not available.

Example. A Nigerian company needs $10 million for a US subsidiary but borrows at 9% in dollars, whereas in naira it can borrow at 22%. A US company needs naira for a Nigerian subsidiary but can borrow dollars at 6.5%.

They arrange a swap at ₦1,345/$1:

• the Nigerian company borrows ₦13.45 billion locally and exchanges it for $10 million
• each year it pays the US company $650,000 (6.5% of $10 million) and receives ₦2.959 billion (22% of ₦13.45 billion), which it uses to pay the naira interest
• at the end the principal is exchanged back at ₦1,345

The Nigerian company has in effect borrowed dollars at 6.5% instead of 9%, saving $250,000 a year, and has no exchange rate risk on the loan.

The risks are the counterparty defaulting and the need to find a counterparty with matching needs, which is why banks arrange most swaps.

Futures compared with forward contracts, and choosing

To choose:

• use a forward for a known amount and date
• a future where an exchange market exists and the company wants easy exit
• an option where the transaction is uncertain (a tender not yet won) or the company wants to keep the upside
• a swap for long-term foreign currency debt

Futures and forwards remove the upside; options keep it at the cost of the premium.

The ideas in more depth

Why an option is insurance and a forward is a commitment

A forward fixes the rate with no cost at the start but leaves the company with the loss of any favourable move. An option costs a premium at the start, like an insurance premium, and in return the company is covered on the downside while keeping the upside.

The premium is the price of that flexibility, so an option is the right choice when the company is not sure the transaction will happen, since an unwanted forward must still be completed at a possible loss, whereas an unwanted option is simply allowed to lapse.

Why futures hedges are imperfect

The contract size is standard, so the number of contracts rarely matches the exposure exactly; the expiry date rarely matches the transaction date; and the futures price and the spot rate may not converge as expected (basis risk). Each adds a small residual risk, which is the price of the lower cost and liquidity of an exchange-traded instrument.

Sources and references

• Currency derivatives are offered through authorised dealers and recognised exchanges, under the rules of the Central Bank of Nigeria and the Securities and Exchange Commission; the prices and rates in the examples are illustrative. The syllabus treats futures, options and swaps at an introductory level; the instruments are covered in more detail at the next level of study.

These points are stated as at 5 November 2026.

Worked examples

1. Contracts.
   1,000,000 ÷ 50,000 = 20; a perfect hedge.

1. Gain.
   (1,468 − 1,415) × 50,000 × 20 = ₦53,000,000.

1. Exercise.
   500,000 × 1,380 = ₦690,000,000.
2. Net of premium. ₦684,000,000.

How to answer in the exam

• Choose the instrument that matches the exposure (buy futures or a call for a payment; sell futures or buy a put for a receipt).
• Work through the steps and show the result for each possible rate.
• Include the premium or margin in the cost.
• Compare with the forward and give the limits of each.

Common mistakes in the exam

• Buying a call when a put is needed, or the reverse.
• Forgetting to deduct the option premium.
• Rounding the number of contracts without saying the hedge is imperfect.
• Choosing an expiry before the transaction date.
• Ignoring the margin and daily settlement of futures.
• Treating an option as an obligation.

Quick revision

• Futures: standard, exchange-traded, margined; buy for a payment, sell for a receipt.
• Options: call for a payment, put for a receipt; premium paid; exercise only if better.
• Swaps: exchange principal and interest in two currencies; principal re-exchanged at the start rate.
• Forward: binding, tailor-made, no margin; future: standard, margined, basis risk.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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