A foreign exchange derivative is a financial derivative whose payoff depends on the foreign exchange rate s of two or more currencies. These instruments are commonly used for currency speculation and arbitrage or for hedging foreign exchange risk.

Foreign exchange transactions can be traced back to the fourteenth Century in the UK, but the coming into being and development of foreign exchange derivatives market was in the s with the historical background and economic environment.

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Firstly, after the collapse of the Bretton Woods system, in , IMF held a meeting in Jamaica and reached the Jamaica agreement. When floating exchange rate system replacing a fixed exchange rate system, many countries had gradually relaxed the control of interest rate and the risk of financial market increased.

In order to reduce and avoid risks and achieve the purpose of hedging, modern financial derivatives came into being. Secondly, economic globalization promoted the globalization of financial activities and financial markets. After the collapse of the Bretton Woods system, a large number of capitals flew across the world.

Countries generally relaxed restrictions on domestic and foreign financial institutions and foreign investors. Changes in macroeconomic factors led to the market risk and the demand for foreign exchange derivatives market increasing further, what promoted the development of the derivatives market. Under such circumstances, financial institutions continue to create new financial tools to meet the needs of traders for avoiding the risk.

Therefore, a large number of foreign exchange derivatives was widely used, making the foreign exchange market expanded from the traditional transactions market to the derivatives market, and develop rapidly.

The end of contract mostly adopt the settlement for differences. At the same time, the buyers need not to present full payment only when the physical delivery gets performed on the maturity date.

Therefore, the characters of trading financial derivatives include the lever effect.

When margin decreases, the risk of trading will increase, as the lever effect will increase. All of traditional risk-management tools insurance, asset-liability management, portfolio etc.

It mainly refers to raise the efficiency of business running and financial market. The latter reflected as it enriches and completes financial market system by countless kinds of products, reduces the occurrence of asymmetric information, realizes the desirable arrangement of risk, increases the efficiency in pricing etc.

Margin needs to make corresponding adjustment on time according to the price of contract.

Foreign exchange derivatives can allow investors to engage in risk avoidance to keep value, but also can earn profit through speculation. This kind of specific duality makes derivatives more uncontrollable. Thus, foreign exchange derivative products can be risky while rewardable.

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What is CURRENCY DERIVATIVE? definition of CURRENCY DERIVATIVE (Black's Law Dictionary)

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Terms Credit spread Debit spread Exercise Expiration Moneyness Open interest Pin risk Risk-free interest rate Strike price the Greeks Volatility.