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What is a FX derivative?

A foreign exchange (FX) derivative is a type of derivative whose payoff depends on the FX rates of two or more currencies. The market for FX is measured in trillions of dollars, and includes a substantial amount of FX derivative contracts. Majority of all FX trades involve the US dollar, which is considered to be the world's premier reserve currency.

The majority of FX trades take place in the ‘spot’ market, where buyers or sellers trade foreign currencies on the price quoted at the time of the trade. Such trades are usually settled within two business days of execution. Most FX derivatives are short-dated with a maturity date of less than one year, meaning that FX derivatives carry less credit risk than other types of derivative.

In the case of FX derivatives, there are a number of types of transactions which are commonplace, such as forwards, swaps and options.

FX derivative contracts can be traded over-the-counter (OTC) or on an exchange.

Common FX derivatives and their uses

There are three main