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C H A P T E R 5

C H A P T E R 5. Currency Derivatives. Chapter Overview. A. Forward Market B. Currency Futures Market C. Currency Options Market D. Currency Call Options E. Currency Put Options F. Contingency Graphs for Currency Options G. Conditional Currency Options. Chapter 5 Objectives.

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C H A P T E R 5

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  1. C H A P T E R 5 Currency Derivatives

  2. Chapter Overview A. Forward Market B. Currency Futures Market C. Currency Options Market D. Currency Call Options E. Currency Put Options F. Contingency Graphs for Currency Options G. Conditional Currency Options

  3. Chapter 5 Objectives This chapter will: A. Explain how forward contracts are used to hedge based on anticipated exchange rate movements B. Describe how currency futures contracts are used to speculate or hedge based on anticipated exchange rate movements C. Explain how currency option contracts are used to speculate or hedge based on anticipated exchange rate movements

  4. A. Forward Market 1. How MNC’s Use Forward Contracts a. Bid/Ask Spread b. Premium or Discount on the Forward Rate c. Arbitrage d. Movements in the Forward Rate over Time e. Offsetting a Forward Contract f. Using Forward Contracts for Swap Transactions

  5. A. Forward Market 2. Non-Deliverable Forward Contracts a. New type b. Frequently used for currency in emerging markets c. No delivery required d. One party to the agreement makes a payment to the other party based on the exchange rate at the future date.

  6. B. Currency Futures Market 1. Contract Specifications 2. Trading Futures 3. Comparison of Currency Futures and Forward Contracts 4. Pricing Currency Futures 5. Credit Risk of Currency Futures Contracts

  7. B. Currency Futures Market 6. Speculation with Currency Futures a. Currency Futures Market Efficiency If the currency futures market is efficient, the futures price for a currency at any given point in time should reflect all available information.

  8. B. Currency Futures Market 7. How Firms Use Currency Futures a. Purchasing Futures to Hedge Payables Source of Gains from Buying Currency Futures

  9. B. Currency Futures Market b. Selling Futures to Hedge Receivables 8. Closing Out a Futures Position 9. Transaction Costs of Currency Futures

  10. C. Currency Options Market 1. Option Exchanges 2. Over-the-Counter Market

  11. D. Currency Call Options 1. Factors Affecting Currency Call Option Premiums a. Level of existing spot price relative to strike price b. Length of time before the expiration date c. Potential variability of currency

  12. D. Currency Call Options 2. How Firms Use Currency Call Options a. Using Call Options to Hedge Payables b. Using Call Options to Hedge Project Bidding c. Using Call Options to Hedge Target Bidding

  13. D. Currency Call Options 3. Speculating with Currency Call Options a. Break-Even Point from Speculation

  14. E. Currency Put Options 1. Factors Affecting Currency Put Option Premiums 2. Hedging with Currency Put Options 3. Speculating with Currency Put Options a. Speculating with Combined Put and Call Options b. Currency Options Market Efficiency

  15. F. Contingency Graphs for Currency Options 1. Contingency Graph for a Purchaser of a Call Option 2. Contingency Graph for a Seller of a Call Option 3. Contingency Graph for a Buyer of a Put Option 4. Contingency Graph for a Seller of a Put Option

  16. Contingency Graphs for Currency Options Insert exhibit 5.6 page 123

  17. G. Conditional Currency Options 1. Conditional Premiums 2. When to Choose Conditional Option

  18. Comparison of Conditional and Basic Currency Options Exhibit 5.7

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