What are currency derivatives?

Currency derivatives are financial instruments that derive their value from the price movements of an underlying currency. This means their market value is directly related to the performance of a specific currency or exchange rate. These instruments can take various forms, such as forwards, futures, options, and swaps, allowing traders and investors to hedge against risks associated with currency fluctuations or speculate on changes in currency values.

The understanding of currency derivatives is crucial for financial risk management, as they help participants in the currency markets protect themselves against unfavorable shifts in exchange rates. For instance, if a company expects to receive payments in a foreign currency in the future, it might use a currency derivative to lock in the current exchange rate, thereby minimizing risks related to currency volatility.

The other options describe different financial concepts, such as promises to pay currency (which relate to other types of financial instruments), contracts that provide rights without necessarily being derivatives, and short-term loans in foreign currencies, which do not accurately capture what currency derivatives are or how they function in financial markets.