Advanced Financial Management · Management of international trade and finance

Currency Options and Swaps for ACCA AFM

Updated 11 October 2026 · Fact-checked

A currency option gives the right, not the obligation, to buy or sell currency at a fixed rate for a premium. A currency swap exchanges principal and interest in two currencies. To solve questions, pick the right option type, compare outcomes at different spot rates, include the premium, then choose the instrument.

Understand Currency Options and Swaps

Foreign exchange risk means a future foreign currency cash flow may be worth less than you expect. Forwards fix the rate. That removes the bad outcome but also removes the good one. Options and swaps give other ways to manage this.

A currency option gives the holder the right, but not the obligation, to buy (call) or sell (put) a currency at the exercise (strike) price. The holder pays a premium up front, whatever happens. If the market rate ends up better than the strike, the holder lets the option lapse and uses the market. If it ends up worse, the holder exercises. So you get protection against bad moves and keep the benefit of good moves. The cost is the premium.

Choose the type by asking what you want to do with the foreign currency. If you will receive foreign currency, you want to sell it, so you buy a put. If you will pay foreign currency, you want to buy it, so you buy a call. Check this against the currency pair in the question, because a put on one currency is a call on the other.

Options come in two forms. Exchange-traded options are standardised: fixed contract sizes, fixed expiry dates and strike prices, a clearing house and margin, and they can be sold on before expiry. OTC options are bought from a bank. The amount, strike and date are tailored to your exposure, so there is no hedge mismatch. But you carry counterparty risk, and they are harder to sell on. OTC options are usually priced by the bank. Exchange-traded options are priced by the market.

A currency swap is an agreement to exchange principal and interest payments in one currency for those in another, for a set period. Principal is usually exchanged at the start and swapped back at maturity at the same rate. Swaps hedge longer-term exposures than forwards or options normally cover. They can also give access to cheaper borrowing in another currency. Counterparty risk remains, because if the other side defaults you still owe your own loan.

Key rules to remember

Option type for a receipt: Receive foreign currency → buy a put on that currency; You want to sell the currency at a guaranteed minimum rate.
Option type for a payment: Pay foreign currency → buy a call on that currency; You want to buy the currency at a guaranteed maximum rate.
Premium cost: Total premium = premium per unit × amount hedged; Paid at the start. If asked, add interest to the date of the exposure.
Exercise decision (put, selling currency): Exercise if spot < strike; otherwise abandon and sell at spot; For a call (buying currency): exercise if spot > strike.
Effective rate with an option: Put: net rate ≈ strike − premium per unit (if exercised). Call: strike + premium per unit.; Premium and strike must be in the same currency terms. Ignores interest on the premium.
Number of exchange-traded contracts: Contracts = exposure ÷ contract size (round to whole contracts); Rounding leaves a small unhedged amount, which you settle at spot.
Black-Scholes call (currency, when foreign rate given): c = S × e^(−rf×T) × N(d1) − X × e^(−rd×T) × N(d2); S spot, X strike, rd domestic rate, rf foreign rate. Use it only if the question gives the inputs and expects it. If rf is ignored it reduces to the standard share formula.
d1 and d2: d1 = [ln(S ÷ X) + (rd − rf + σ²÷2) × T] ÷ (σ × √T); d2 = d1 − σ × √T; σ is the annualised volatility of the exchange rate.
Put-call parity (same inputs): p = c − S × e^(−rf×T) + X × e^(−rd×T); For European options. If rf = 0 it is the usual c − S + X × e^(−rT).

How to solve Currency Options and Swaps questions

Use this order for any currency options or swaps question. It stops you hedging in the wrong direction and keeps each calculation tidy.

1Identify the exposure: the currency, the amount, whether it is a receipt or payment, and the date.
2Choose the instrument type. Receipt of foreign currency needs a put; payment needs a call. For swaps, say who has the currency need and who has the matching opposite need.
3Set up the numbers: strike, premium per unit, contract size or amount. Convert the premium into the currency you will compare in. Use the right side of any bid-offer spread.
4Work out the outcome at each spot rate given. Compare the strike with spot: exercise or abandon. Add the premium cost, with interest if the question asks.
5Show the comparison with the forward, money market hedge or no hedge. Find the break-even spot rate if asked.
6For swaps, list the cash flows at the start, each interest date and maturity. Show the net result for each party and any savings compared with borrowing directly.
7Conclude with a recommendation. Tie it to the scenario: risk appetite, certainty of the cash flow, cost, counterparty risk and the length of the exposure. Use the professional skills marks.

Quickest way: Three-line outcome table

When to use it: Use it when the question gives two or three possible spot rates and asks you to compare the option with a forward or no hedge.

Write the hedged amount per unit at each spot: put receipt = higher of strike and spot; call payment = lower of strike and spot.
Subtract (receipt) or add (payment) the premium per unit. Then multiply by the total amount.
Put the forward result beside it. The break-even spot is where the option's net rate equals the forward rate.

Common mistakes in Currency Options and Swaps

Buying the wrong type of option, for example a call when receiving foreign currency.
Students think of the option on the currency they are receiving, not what they are doing with it. Quoted pairs can also flip the direction.
Fix: Say in words what you will do with the foreign currency. Receiving it means selling it, so a put. Check the pair quoted in the question.
Forgetting the premium, or deducting it from the wrong figure.
Students focus on the exercise decision and treat the premium as an afterthought.
Fix: Always show the premium as a separate line, even in the abandon case. It is paid whichever way the market moves.
Rounding the number of exchange-traded contracts incorrectly, or ignoring the part not covered by contracts.
Contract size is easy to overlook in a long question.
Fix: Divide the exposure by the contract size, round to whole contracts, and treat the remainder as unhedged at spot or hedged another way.
Using the wrong exchange rate from the bid-offer spread.
Students pick the first rate they see.
Fix: The bank buys foreign currency at the lower rate for a receipt and sells it at the higher rate for a payment, in the usual quote. Write which rate you use and why.
Describing a swap as removing all risk.
Exam answers focus on the exchange of currency and miss credit risk.
Fix: State that the swap fixes the exchange rate and interest cost, but counterparty default, and the cost of unwinding early, remain.
Applying Black-Scholes without checking the inputs, for example using annual rates for a three-month period.
Time T must be in years, and rates and volatility must be annual.
Fix: Convert T to years first (3 months = 0.25). Keep rd, rf and σ annualised. Show the d1 and d2 working so you earn method marks.

Worked examples

Example 1

A US company will receive €5,000,000 in three months. Spot is $1.1000 per €. A three-month forward rate is $1.0950 per €. An OTC euro put option with a strike of $1.1000 per € costs $0.015 per €. Ignore interest on the premium. Calculate the net dollar receipt using the option if the spot rate in three months is (a) $1.0600 and (b) $1.1600. Compare each with the forward, and find the spot rate above which the option beats the forward.

Show the solution

The company receives euros, so it wants to sell euros. It buys a euro put.
Premium = 5,000,000 × $0.015 = $75,000, paid now.
(a) Spot $1.0600 is below the strike $1.1000, so exercise. Receipt = 5,000,000 × 1.1000 = $5,500,000. Net = 5,500,000 − 75,000 = $5,425,000.
(b) Spot $1.1600 is above the strike, so abandon and sell at spot. Receipt = 5,000,000 × 1.1600 = $5,800,000. Net = 5,800,000 − 75,000 = $5,725,000.
Forward: 5,000,000 × 1.0950 = $5,475,000.
At (a), the option gives $5,425,000, which is $50,000 less than the forward. At (b), the option gives $5,725,000, which is $250,000 more than the forward.
Break-even: when the option is abandoned, net per € = spot − 0.015. Set this equal to 1.0950. Spot = 1.1100. Above $1.1100 per €, the option beats the forward.

Answer: Net receipts: (a) $5,425,000; (b) $5,725,000. The forward gives $5,475,000. The option is better than the forward only if the spot rate is above $1.1100 per €. The minimum guaranteed net rate is $1.0850 per €.

Example 2

Company X (US) has borrowed $11,000,000 at 5% fixed for three years and needs €10,000,000 for its euro subsidiary. Company Y (eurozone) has borrowed €10,000,000 at 4% fixed for three years and needs $11,000,000. The spot rate is $1.10 per €. They agree a currency swap with principal exchanged at the start and the end at $1.10 per €, and each party pays the interest on the currency it receives. Show X's cash flows and explain the benefit to X if the dollar needed at maturity would otherwise cost €11,000,000 because the spot rate has fallen to $1.00 per €. Ignore bank fees.

Show the solution

Start: X gives Y $11,000,000 and receives €10,000,000. X has the euros it needs.
Each year: X pays its bank $11,000,000 × 5% = $550,000. Y pays X $550,000 (the interest on the dollars it received). X pays Y €10,000,000 × 4% = €400,000, which Y uses on its euro loan.
Net annual cost to X: €400,000 in euros. The dollar interest paid to the bank is covered by Y's payment.
Maturity: X receives $11,000,000 from Y and uses it to repay its bank. X pays Y €10,000,000, which Y uses to repay its euro loan.
Effect: X has in effect a €10,000,000 loan at 4% fixed with no exchange rate risk on principal or interest.
If X had not swapped and the rate falls to $1.00 per €, the $11,000,000 repayment would cost 11,000,000 ÷ 1.00 = €11,000,000. Under the swap, X pays back €10,000,000. The saving on principal is €1,000,000.

Answer: X's net cost is €400,000 interest each year and €10,000,000 principal at maturity, fixed. At a spot of $1.00 per €, X saves €1,000,000 on principal compared with repaying $11,000,000 unhedged. The remaining risk is that Y defaults.

Exam tips

Read whether the question wants a calculation, a comparison or a recommendation. Often it wants all three, and the recommendation carries professional skills marks.
Always state the direction of the hedge first: put or call, and why. It shows the examiner you understand the exposure.
If you are asked to compare OTC and exchange-traded options, give pairs: tailored versus standard, counterparty risk versus clearing house, flexibility versus liquidity, and premium versus margin.
For Black-Scholes, use the inputs the question gives. Show each step, such as d1, d2, N(d1) and N(d2) from the tables, so you earn method marks even if a number is wrong.
In a recommendation, link the choice to the scenario: how certain the cash flow is, the board's risk appetite, the length of the exposure, and any limits on counterparty risk.

Practice questions from Management of international trade and finance

Currency Options and Swaps in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Currency Options and Swaps: frequently asked questions

What is the difference between OTC and exchange-traded currency options?

Exchange-traded options have standard contract sizes, expiry dates and strikes, and a clearing house stands behind them. OTC options are agreed with a bank and tailored to your exact amount and date, but you carry the bank's credit risk. OTC options suit exact exposures; traded options suit smaller or more flexible needs.

How do I decide between a currency option, a forward and a swap?

Use a forward when you want a fixed rate and the cash flow is certain. Use an option when you want protection but also want to benefit from a favourable move, and can pay a premium. Use a swap for longer-term exposures, typically involving loans and regular interest payments.

Can I use Black-Scholes to value a currency option in ACCA AFM?

Yes, if the question gives you the inputs and asks for it. Treat the exchange rate like the share price, use the domestic risk-free rate, and adjust for the foreign rate if one is given. Keep T in years and show every step.

Why does a currency swap not remove all risk?

It fixes the exchange rate and the interest cost, but you still depend on the counterparty to make its payments. If it defaults you still owe your own lender. Some swaps also have a cost if you end them early.