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Currency Futures and Options Markets

Currency Futures and Options Markets. Chapter 8. PART I.FUTURES CONTRACTS. I. CURRENCY FUTURES Definition: contracts written requiring a standard quantity of an available currency at a fixed exchange rate at a set delivery date.

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Currency Futures and Options Markets

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  1. Currency Futures and Options Markets Chapter 8

  2. PART I.FUTURES CONTRACTS • I. CURRENCY FUTURES • Definition: • contracts written requiring a standard quantity of an available currency at a fixed exchange rate at a set delivery date. • Private individuals are encouraged. Contracts have minimum price moves and daily price limits exist to restrict max daily price move

  3. FUTURES CONTRACTS • 2. IMM (International Monetary Market) provides • a. an outlet for hedging currency • risk with futures contracts.

  4. FUTURES CONTRACTS • b.Available Futures Currencies/Contract Size: • 1.) British pound / 62,500 • 2.) Canadian dollar /100,000 • 3.) Euro / 125,000 • 4.) Swiss franc / 125,000 5.) Japanese yen / 12.5 million • 6.) Mexican peso / 500,000 • 7.) Australian dollar / 100,000

  5. FUTURES CONTRACTS • c. Transaction costs: • commission payment to a floor trader • d. Leverage is high • 1.) Initial margin required is relatively low (less than 2% of contract value).

  6. FUTURES CONTRACTS: SAFEGUARDS • e. Maximum price movements • 1.) Contracts set to a daily price limit restricting maximum daily price movements. • 2.) If limit is reached, a margin call may be necessary to maintain a minimum margin.

  7. FUTURES CONTRACTS • g. Global futures exchanges: • 1.) I.M.M. International Monetary Market • 2.) L.I.F.F.E.London International Financial Futures Exchange • 3.) C.B.O.T. Chicago Board of Trade • 4.) S.I.M.E.X.Singapore International • Monetary Exchange • 5.) D.T.B. Deutsche Termin Bourse • 6.) H.K.F.E. Hong Kong Futures Exchange

  8. FUTURES CONTRACTS • B. Forward vs. Futures Contracts • Basic differences: • 1. Trading Locations 6. Quotes • 2. Regulation 7. Margins • 3. Frequency of 8. Credit risk • delivery • 4. Size of contract • 5. Transaction Costs

  9. Advantages of futures: 1.) Easy liquidation 2.) Well- organized and stable market. Disadvantages of futures: 1.) Limited to 7 currencies 2.) Limited dates of delivery 3.) Rigid contract sizes. FUTURES CONTRACTS

  10. Profits and losses are paid over every day at the end of trading, a practice called marking to market. Example: An investor, on Tuesday morning, takes a long position in Swiss Franc futures contract that matures on Thursday afternoon. The price is $0,75 for SFr 125,000. (a) On Tuesday closing, price has risen to $0,755.  Investor receives cash profit of $625 (125,000*0,005)  The initial contract is cancelled.  Investor receives a new contract with the current price. The value of the contract is set to zero at the end of everyday. (b) On Wednesday, price declines to $0.743.  Loss is $1500 (125,000*0.012)  New contract at the same price (c) On Thursday, price drops to $0.74. Investor pays $375 loss and takes delivery of Swiss Francs, paying the prevailing price of $0.74. FUTURES CONTRACTS

  11. CURRENCY OPTIONS PART II

  12. CURRENCY OPTIONS • I. OPTIONS • A. Currency options • 1. Offer another method to hedge exchange rate risk. • 2. First offered on Philadelphia • Exchange (PHLX). • 3. Fastest growing segment of • the hedge markets.

  13. CURRENCY OPTIONS • Buyers Sellers=Writers Premium Sell Buy Sell Buy PUT CALL

  14. CURRENCY OPTIONS • 4. Definition: • A contract from a writer ( the seller) that gives the right not the obligation to the holder (the buyer) to buy or sell a standard amount of an available currency at a fixed exchange rate for a fixed time period.

  15. CURRENCY OPTIONS • 5. Expiration Dates of Currency Options: • a. American • Exercise date may occur any time up to the expiration date. • b. European • Exercise date occurs only at the • expiration date and not before.

  16. CURRENCY OPTIONS • 7. Exercise Price • a. Sometimes known as the • strike price. • b. The exchange rate at which the option holder can buy or sell the contracted currency.

  17. CURRENCY OPTIONS • c. Types of Currency Options: • 1.) Calls • 2.) Puts

  18. CURRENCY OPTIONS • 8. Status of an option • a. In-the-money • Call: Spot > strike • Put: Spot < strike • b. Out-of-the-money • Call: Spot < strike • Put: Spot > strike • c. At-the-money • Spot= the strike

  19. CURRENCY OPTIONS • 9. What is the premium? • - The price of an option that the writer charges the buyer. • B. Why Use Currency Options? • 1. For the firm hedging foreign exchange risk with Future event is very uncertain gains.

  20. CURRENCY OPTIONS • 2. For speculators • - profit from favorable exchange rate changes.

  21. CURRENCY OPTIONS • C. Using Forward or Futures Contracts • Forward or futures contracts are • more suitable for hedging a known amount of foreign currency flow.

  22. Options Sample Problems • Ford buys a French put option (contract size: FF250,000) at a premium of $.01/FF. If the exercise price is $.21 and the spot at expiration is $.216, what is Ford’s profit (loss)?

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