•  Hedgers
• Use derivatives to hedge the risks they face from volatility in the asset prices
• Example: a company is getting a cash inflow in 3 months time in a foreign currency. It hedges its currency risk by taking a short position in a currency forward at a particular price
• Speculators
• Use derivatives to bet on a particular direction of movement of the asset price
• If a speculator believes that the SR of a foreign currency will be higher in 3 months than its present 3 month forward rate, he goes long on the forward. After 3 months if he is correct, he receives foreign currency at lower rate and immediately resells it at the higher SR
• Arbitrageurs
• Take offsetting positions in 2 or more instruments to lock a profit
• Suppose that:
• The spot price of gold is US$390 • The quoted 1-year forward price of gold is US$425
• The 1-year US\$ interest rate is 5% per annum
• No income or storage costs for gold. Is there an arbitrage opportunity?
• Forward Rate : S = 390, T = 1, and r = 0.05 so that F = 390 (1 + 0.05) = 409.50
• Arbitrage = Buy Low â€“ Sell High at no risk