The derivatives involved include swaps and options that are a sort of insurance that firms with exposure to dollars or other currencies buy as a protection against any adverse movement in these currencies that can hurt their income (for exporters) or increase their liabilities (for those companies that have borrowed overseas).
Theoretically, a swap is a financial transaction in which two counterparties agree to exchange a stream of payments over time at an agreed price. An option is an agreement between two parties in which one grants to the other the right to buy or sell an asset under specified conditions.
Thus, in case of a currency swap, both parties have the right and obligation to exchange currencies. And in the case of options, the buyer has the right but no obligation and the seller, the obligation but not the right to exchange currencies.
Many firms have posted notional losses on account of derivatives contracts and the quantum of losses would have been much higher had dollar not started appreciating against other currencies. such as Japanese yen and Swiss franc. At the core of the legal battle is a debate whether these instruments were sold for hedging or speculation.
The banks say they were sold for hedging. The firms claim they were for speculation.
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