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Shapiro: Chapter 7 Currency Futures and Options Markets

Shapiro: Chapter 7 Currency Futures and Options Markets. Chapter 7 Problems 1, 5, 8. Forward vs. Futures Contracts: A Comparison. Currency Futures Contracts. Advantages : Smaller size of contract Ability to liquidate position Well-organized market. Currency Futures Contracts.

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Shapiro: Chapter 7 Currency Futures and Options Markets

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  1. Shapiro: Chapter 7Currency Futures and Options Markets

  2. Chapter 7 Problems1, 5, 8

  3. Forward vs. Futures Contracts: A Comparison

  4. Currency Futures Contracts • Advantages: • Smaller size of contract • Ability to liquidate position • Well-organized market

  5. Currency Futures Contracts • Disadvantages: • Limited currencies: • A$; R$; £; Can$; CZK; €; Ft; ¥; Mex$; $NZ; NKr; PLN; Rb; R; SKr; SFr • Limited delivery dates • Restricted contractual amounts • Example: £ 62,500

  6. Currency Futures Contracts • Conclusion: • “... mainly benefits firms with stable and continuous payments or receipts in the traded currencies.”

  7. Currency Futures Contracts Currency Futures Newspaper Listing

  8. Chicago MercantileExchange (CME) • www.cme.com

  9. Shapiro: Problem 7.1

  10. Contract Cash Time Action Taken Value Flow $121,875 Monday Buys pound futures None contract at £1=$1.95 AM [Shap6-1]

  11. Contract Cash Time Action Taken Value Flow $121,875 Monday Buys pound futures None contract at £1=$1.95 AM $122,500 + $625.00 Monday Futures price rises to £1=$1.96 Close [Shap6-1]

  12. Contract Cash Time Action Taken Value Flow $121,875 Monday Buys pound futures None contract at £1=$1.95 AM $122,500 + $625.00 Monday Futures price rises to £1=$1.96 Close $123,750 + $1,250.00 Tuesday Futures price rises to £1=$1.98 Close [Shap6-1]

  13. Contract Cash Time Action Taken Value Flow $121,875 Monday Buys pound futures None contract at £1=$1.95 AM $122,500 + $625.00 Monday Futures price rises to £1=$1.96 Close $123,750 + $1,250.00 Tuesday Futures price rises to £1=$1.98 Close - $1,562.50 $122,187.50 Futures price Wednesday falls to £1=$1.955 Close [Shap6-1]

  14. Contract Cash Time Action Taken Value Flow $121,875 Monday Buys pound futures None contract at £1=$1.95 AM $122,500 + $625.00 Monday Futures price rises to £1=$1.96 Close $123,750 + $1,250.00 Tuesday Futures price rises to £1=$1.98 Close - $1,562.50 $122,187.50 Futures price Wednesday falls to £1=$1.955 Close + $312.50 Net Profit

  15. Currency Options

  16. Currency Options • Forward and futures contracts - both protect against adverse price movements, but ... • they eliminate the possibility of gaining a profit from favorable movements.

  17. Option Pricing and Valuation(Price = Intrinsic Value + Time Value) • Intrinsic Value (IV): • IV = S - E, where • S = spot price, and • E = exercise price • if E > S, then IV = 0

  18. Option Pricing and Valuation(Price = Intrinsic Value + Time Value) • Time Value (TV): • Excess of price over IV • TV = P - IV • Time value is always positive • Longer maturity, greater TV • “Wasting Asset” - TV declines to zero at maturity

  19. Currency Options(Philadelphia Stock Exchange; 1983) • Buyer (holder) has right to sell (put) or buy (call) at exercise (strike) price until expiration date

  20. Currency Options(Philadelphia Stock Exchange; 1983) • Seller must perform if exercised • Option buyer pays a premium • Option seller receives a premium

  21. Currency Options(Philadelphia Stock Exchange; 1983) • American option - exercised any time • European option - exercised only at maturity

  22. Currency Call Options(Philadelphia Stock Exchange; 1983) • “in-the-money” - spot price greater than exercise price (S > E) • “out-of-the-money” - spot price less than exercise price (S < E) • “at-the-money” - spot price is equal to exercise price (S = E)

  23. Currency Options Contracts Currency Options Newspaper Listing

  24. Currency Options Shapiro: Exhibit 7.5

  25. Shapiro: Problem 7-5 • Citigroup sells a €500,000 call option at a premium of $0.04 per Euro • Exercise price = $1.34 • Expiration spot price = $1.36 • Citigroup’s profit or loss?

  26. Shapiro: Problem 7-5 • Citigroup receives: • €500,000 X $0.04 = $ 20,000 • €500,000 X $1.34 = $670,000 • Citigroup pays: • €500,000 X $1.36 = $680,000 • Net gain (loss): • $690,000 - $680,000 = $10,000

  27. Shapiro: Problem 7.8 • Apex Corp. owes ¥125 million in 90 days. • Current spot rate : ¥1 = $0.007823

  28. Shapiro: Problem 7.8 • Apex Corp. owes ¥ 125 million in 90 days. • Current spot rate : ¥1 = $0.007823

  29. Shapiro: Problem 7.8 • What is the risk facing Apex? • Is Apex “long” or “short”?

  30. Shapiro: Problem 7.8

  31. Shapiro: Problem 7.8

  32. Shapiro: Problem 7.8

  33. Shapiro: Problem 7.8

  34. Shapiro: Problem 7.8

  35. Shapiro: Problem 7.8 • Options (20 @ ¥6.25 million) • spot rate: ¥1 = $0.0079(S) • exercise price: ¥1 = $0.0080(E) • S < E; no exercise • loss of option premium • ¥125,000,000 X $0.00015 = $18,750

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