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Currency Futures & Options Markets

Currency Futures & Options Markets. Financial Derivatives. Contracts that derive their value from some underlying asset Forwards Futures Options Swaps. Currency Futures.

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Currency Futures & Options Markets

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  1. Currency Futures & Options Markets

  2. Financial Derivatives • Contracts that derive their value from some underlying asset • Forwards • Futures • Options • Swaps

  3. Currency Futures Performance Bond or Initial Margin: The customer must put up funds to guarantee the fulfillment of the contract - cash, letter of credit, Treasuries Maintenance Performance Bond or Margin: The minimum amount the performance bondcan fall to before being fully replenished Mark-to-the-Market: A daily settlement procedure that marks profits or losses incurred on the futures to the customer’s margin account.

  4. Long and Short Exposures • A person that is, for example, long the pound, has pound denominated assets that exceed in value their pound denominated liabilities. • A person that is short the pound, has pound denominated liabilities that exceed in value their pound denominated assets.

  5. Hedging With a Currency Future • To hedge a foreign exchange exposure, the customer assumes a position in the opposite direction of the exposure. • For example, if the customer is long the pound, they would short the futures market. • A customer that is long in the futures market is betting on an increase in the value of the currency, whereas with a short position they are betting on a decrease in the value of the currency.

  6. SAFEGUARDS 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. 3.) Marking to Market 4.) Eliminating default 5.) Delivery cancelled

  7. 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. Forward vs. Futures ContractsBasic 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. Why would you use them? Advantages of futures: 1.)High leverage(2%) 2.) Easy liquidation 3.) Well- organized and stable market. Disadvantages of futures: 1.) Limited to 7 currencies 2.) Limited dates of delivery 3.) Rigid contract sizes.

  10. Currency Options • A currency option is a contract that gives the owner the right, but not the obligation, to buy or sell a currency at a specified price at or during a given time. • Call Option: An option that gives the owner the right to buy a currency. • Put Option: An option that gives the owner the right to sell a currency.

  11. Currency Options • American Option: An option that can be exercised any time before or on the expiration date. • European Option: An option that can only be exercised on the expiration date.

  12. Currency Options • Exercise or Strike Price: The price (spot exchange rate) at which the option may be exercised. • Option Premium: The amount that must be paid to purchase the option contract. • Break-Even: The point at which exercising the option exactly matches the premium paid.

  13. Currency Options • If the spot rate has not yet reached the exercise price [S<X], the option cannot be exercised and is said to be “out of the money.” • If the spot rate equals the exercise price [S=X], the option is said to be “at the money.” • If the spot rate has surpassed the exercise price [S>X], the option is said to be “in the money.”

  14. Call Option • The holder of a call option expects the underlying currency to appreciate in value. • Consider 4 call options on the euro, with a strike price of 92 ($/€) and a premium of 0.94 (both cents per €). • The face amount of a euro option is €62,500. • The total premium is: $0.0094·4·€62,500=$2,350.

  15. Put Option • The holder of a put option expects the underlying currency to depreciate in value. • Consider 8 put options on the euro with a strike of 90 ($/€) and a premium of 1.95 (both cents per €). • The face amount of a euro option is €62,500. • The total premium is: $0.0195·8·€62,500=$9,750.

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