a) Compare and critically evaluate the two methods of managing foreign exchange rate risks: forward contracts and options contracts. (b) Critically discuss why developing/emerging countries tend to favor a fixed exchange rate system in practice. Give examples to illustrate your answer.

The discussion is valid but not precise and concise enough. Please add more explanation to be precise and concise with the journal academics for each parts.

a) Foreign exchange rate risk management is essential for firms with operations on a worldwide scale. Forward contracts and options contracts are two different strategies that are frequently employed to mitigate this risk. Foreign currency rate risks can be managed through forward contracts and options contracts. A forward contract is a legally binding arrangement between two parties that involves exchanging a set quantity of one currency for another at a defined exchange rate at a future date. The purchaser of an option contract has the choice, however not the duty, to purchase or sell a currency at a particular exchange rate on or before a certain date in the future. According to one research by Hakansson and Tong (1982), forward contracts are more efficient than Options contracts to reduce the risks associated with foreign currency rates. They contend that due to the fact forward contracts set the exchange rate and reduce unpredictability, they offer greater security over fluctuations in currencies. Contrarily, options contracts provide only a limited level of security since the individual who holds them is not required to exercise the option and can lose out on advantageous changes in exchange rates.

Furthermore, businesses that are required to lock in a precise exchange rate for upcoming transactions should use forward contracts. However, because the terms of the agreement have been carved in stone and are unable to be modified, they do not have flexibility. Contrarily, options contracts offer greater freedom because the purchaser has the choice yet lacks the duty to carry out the transaction.

Options contracts, on the other hand, may occasionally be more advantageous, according to certain academics. For instance, research by Cheng and Neumann (1996) revealed that because option contracts offer versatility in controlling threats over a period of time, options could potentially be more effective for handling long-term currency fears. In a comparable manner, research by Tse and Yip (1991) discovered that option contracts may be more successful in reducing risks related to excessive fluctuations in exchange rates.

b) A fixed exchange rate system is one in which the value of a nation's currency is tied to another currency, such as the US dollar or the euro. This indicates that the country's government has agreed to purchase or trade its currency at a predetermined rate. Developing and expanding nations choose fixed exchange rate arrangements for a variety of reasons. These are a few examples.

• Import and export stability. A fixed exchange rate can assist in bringing import and export pricing under control, which will be advantageous to both companies and customers. This is due to the fact that a fixed exchange rate implies a relationship between the value of the local currency and a different currency, such as the US dollar or the euro. This could assist in lowering unpredictability over the price of imported products and services, which could facilitate corporate planning and customer purchasing.
• Attracting foreign investment. Foreign investment might be attracted by the application of an exchange rate that is predictable. This is because nations, where foreign investors feel certain that their investments will appreciate in value, are more likely to attract their capital. This sense of security can be helped by using a fixed exchange rate.
• Controlling inflation. A fixed exchange rate is another way to keep inflation under control. This is because the government's power to generate money is limited by a fixed exchange rate. When the government generates money, inflation can grow. However, a fixed exchange rate implies that the amount of money that the government may produce is constrained. This may aid in reducing inflation.

However, there are several drawbacks to a fixed exchange rate structure. These are some examples:

• Currency speculation. A fixed exchange rate may leave a nation extremely susceptible to currency speculation. This is due to the fact that the value of the local currency is tied to a different currency, so speculators can gamble about whether the value of the domestic currency will grow or decline. If speculators believe the value of the home currency will decline, they may trade it and purchase another currency. This may reduce the native currency's value, resulting in an economic downturn. If the speculators bet that the value of the domestic currency will fall, they can sell the domestic currency and buy the other currency. This can cause the value of the domestic currency to fall, which can lead to a financial crisis.
• Loss of monetary policy independence. A fixed exchange rate also reduces the government's monetary policy autonomy. This is mainly due to the government's inability to manage inflation or generate economic development through monetary policy. This happens due to the government's insufficient capacity to adjust the interest rate while the exchange rate has been established.

Regardless of the disadvantages, developing and growing nations might benefit from a fixed exchange rate regime. However, it is critical to assess the potential hazards and advantages before deciding whether or not to use a fixed exchange rate system.

As a result of the stability, it offers for business and investment, developing and growing nations frequently adopt fixed exchange rate systems. Fixed exchange rates give certainty and accuracy to foreign transactions, allowing firms to prepare and make investments more effectively. Fixed exchange rates can also encourage international investment by lowering currency risk for foreign investors.

Fixed exchange rates, unfortunately, may pose issues, especially when the currency is overpriced. If a country's currency is overvalued, it might cause an imbalance in its current account, which may give rise to hyperinflation and currency depreciation. For example, in the late 1990s, the Thai baht was tied to the US dollar, resulting in a massive infusion of foreign prosperity into Thailand.