currency futures 2

8/12/2019 Currency Futures 2

1/27

Currency futures A currency future is a futures contract to exchange onecurrency for another at a specified date in the future at a

price (exchange rate) that is predetermined. A currency future is also known as foreign exchange futureor FX future and has foreign currencies as the underlyingassets.One of the currencies in a currency futures contract is theUS dollar.The price of the other currency is expressed in terms of theUS dollar.Currency futures contracts may either be closed out beforethe expiry date or settled through physical delivery of thecurrency.

A currency futures contract is a contract that allows marketparticipants to trade the underlying exchange rate for aperiod of time in the future.


2/27

Currency futures exchanges It was in 1972 that currency futures were first traded in CME(the Chicago Mercantile Exchange).CME is the largest market for exchange-traded currencyfutures in the world and is considered the world's premierexchange for the trading of currency futures and options.Currently most of the deals are done electronically through theelectronic trading platform of the exchange, the GLOBEXsystem.In India, trading in currency futures was launched on August29, 2008.Facilities for currency futures trading are currently available atthree exchanges - the National Stock Exchange (NSE), theMumbai Stock Exchange (BSE) and the MCX Stock Exchange(MCX-SX). At present, only US dollar-rupee futures contracts are permittedto be traded.


3/27


4/27

The British pound futures contracts are quoted inUS dollars per pound and call for physical deliveryat expiration.

Physical delivery takes place on the thirdWednesday of the contract month, in the country ofissuance at a bank designated by the ChicagoMercantile Exchange (CME) Clearing House.

They trade on six months in the March quarterlycycle, namely, March, June, September andDecember.Cross rate currency futures, such as British pound/Japanese yen, British pound/ Swiss franc, Euro/British pound, are also being traded.


5/27

Currency futures contracts are characterized bycertain specifications such as the contract size, tickincrements, tick values, trading hours, expiry dates,

pricing limits, etc. Currency futures are traded only ina limited number of currencies which are usedextensively worldwide.Bri t i sh Pound c ur rency fu tures : It is major currencytraded worldwide by corporations, financial institutions,banks, investment managers, commodity funds, hedgefunds and futures traders.The Chicago Mercantile Exchange began tradingBritish pound currency futures contracts in 1975.

At present, CME offers markets for trading Britishpound futures on its GLOBEX electronic tradingplatform as well as on its trading floor.


6/27

Contract specifications Trading Unit 62,500 pound sterling (British pounds)Trading Hours Floor 7:20 a.m. - 2:00 p.m. LTD (9:16a.m.): GLBX2(GLOBEX) Mon/Thurs 4:30p.m.-4:00p.m., Sun & Holiday5:30p.m.-4:00p.m.Trading Months - Six months in the March quarterly Cycle

March, June, Sep, Dec.Point Description 1 point=$.0001 per pound sterling=$6.25 per contract

Minimum Price Fluctuation

British Pound Futures-regular: 0.0002=$12.50, calendarspread: 0.0001=$6.25British Pound Futures-regular: 0.0001=$6.25, calendarspread: 0.0001=$6.25

tick increments tick values


7/27

Euro currency futures The Euro currency futures (referred to as Euro FX) contractsize is 1,25,000 Euro. Euro FX moves in 1 point or $.0001 perEuro increments, which equals $12.50 per contract. The futurescontract trades six months in the March quarterly cycle, Mar,Jun, Sep, and Dec.Contract SpecificationsTrading Unit 125,000 euro physically delivered

Trading Hours Floor 7:20a.m.-2:00p.m. LTD (9:16a.m.): GLBX2 Mon/Thurs

4:30p.m.-4:00p.m. Sun & Holiday 5:30p.m. - 4:00p.m.Trading Months Six months in the March Quarterly cycle, Mar, Jun, Sep, Dec.

Point Description

1 point = $.0001 per Euro = $12.50 per contractMinimum Price Fluctuation Regular/0.0001 = $12.50, Calendar Spread/0.00005 = $6.25


8/27

example The Swiss Franc futures contract traded at the CMErepresents 125,000 Swiss Francs.( Trading Unit)

Suppose the exchange rate is 0.6010 USD/SF At the price of 0.6010 USD/SF the value of thecontract would be $75,125 (i.e., $0.6010 x 125,000).Now suppose that the price of the Swiss Franc

currency future moved to $0.6020the holder of the contract has profited from theincrease in the value of the contract from$75,125.00 to $75,250.00 or $125.00.


9/27

Another way to calculate the same change in value would beto multiply the change in price (in ticks) by the value of asingle tick.The value of a tick is set by the exchange and represents the

minimum price fluctuation for a particular contract.The minimum fluctuation (tick) of the Swiss Franc contract is.0001 and the value of that tick is $12.50. In our example theprice moved from .6010 to .6020 or 10 ticks or $125.00 (10 x12.50)

Currency futures, just as all other futures contracts, aretraded through brokers.These brokers generally trade for themselves as well as onbehalf of their clients.When they trade for themselves, they are called floor traders.When these brokers trade on behalf of their clients, they areknown as floor brokers or commission brokers as they chargecommission from their clients.


10/27


11/27

When the buyer or the seller of a currency futurescontract realizes a profit on his futures position onaccount of favourable exchange rate movements,the clearing house makes the payment.On the contrary, if the buyer or the seller of acurrency future incurs loss on his futures position,

he has to pay the difference to the clearing house.The clearing house also makes the arrangementsfor delivery of the foreign currency on settlementdate in case of physical delivery.


12/27

Settlement of currency futures contracts Most currency futures contracts on several futuresexchanges have expiry in the months of March, June,

September and December and are settled on the thirdWednesday of these months. A currency futures contract may be settled by physicaldeliveryBut a large proportion of the currency futures contractsare offset prior to the delivery date through a matchingreverse deal.This procedure is known as closing out through cashsettlement.

In this case, the difference between the buying priceand the selling price is paid and received by therespective participants.


13/27

"rolling" and "calendar spread"The buyer or the seller of a currency future can "roll" theposition over from one contract expiration into the next.

If a participant holds a long position or short position in anexpiration month, he can sell that expiration monthcontract and buy the next expiration month contract(known as a "calendar spread")This rolling is for an agreed-upon price differential.By transferring or "rolling" a position forward this way themarket participant is able to hold it for a longer period oftime.For example, if a market participant is holding a JuneEuro currency futures contract, he can sell the Junefutures before expiration and buy a December Eurocurrency futures contract, thereby expanding thetimeframe of the trade.


14/27

Margining and Marking-to-Market In order to provide liquidity and to ensure thatcurrency futures contracts are settled withoutdefault by the participants, a margining system isadopted by the clearing house.Clearing houses charge 2 types of margins - theInitial Margin and the Mark-To-Market margin (also referred to as Variation Margin ).Clearing house also prescribe a minimum balance(known as Maintenance margin) to be maintainedthroughout the period that a participant has anopen position in a currency futures contract.


15/27

When a position is opened (either long or short) a traderis required to pay the initial margin in cash to the clearinghouse.This amount remains on deposit as long as the trader hasan open position on his contract.The initial margin, prescribed by the exchange, dependsupon the nominal value of the contract and it varies fromcurrency to currency.The exchange revalue each position daily at the close ofeach business day based on the closing price of theunderlying currency. This process of revaluation is knownas marking to the market (MTM).

Any difference from the previous days MTM price iseither credited to the margin account of the trader (if itrepresents a gain to the trader) or debited to his marginaccount (if it represents a loss to him) by the clearinghouse.


16/27

When the margin account balance goes belowthe Maintenance margin prescribed by theexchange, the trader has to replenish the marginaccount to the level of the Initial margin.The amount thus remitted to replenish the marginbalance on account of marking to the market processis known as the Mark-to-Market Margin (MTMmargin) or Variation margin .Thus the Mark-to-Market Margin (MTM margin) is themargin collected to offset losses (if any) that has

already been incurred on the positions held by atrader.


17/27

Problem A customer with a $12,000 margin account balance purchased6 September Swiss Franc contracts at the opening price of$.7004 /SF.

The currency futures contract data is as followsUnderlying currency: Swiss FrancContract size: 125,000 Swiss francsNo. of contracts purchased: SixOpening price: $ 0.7004/ SFInitial margin: $1,823 per contractsMaintenance margin: $1,350 per contractThe other events are as follows:Day 1, The settlement price declined to $0.6975.

Day 2, The settlement price increased to $0.7009Day 3, The settlement price declined $0.6884Show the customers Margin Account

Solution


18/27

Solution Customers opening margin account balance =$12,000Purchased 6 September Swiss Franc contracts at an openingprice of $.7004 /SF.

One Swiss Franc contract contains 125,000 Swiss Francs.Therefore1 point = $.0001 per Swiss Frank = $12.50 per contract

Total dollar value of the contracts is: $.7004 X 125,000 X 6 =$525,300.Initial margin for the position = $1,823 x 6 = $10,938.Since the account balance is $12,000, the initial marginrequirement has been met with the cash in the accountfirst day after trading , the settlement price declines to $0.6975The drop in price = 0.7004 - 0.6975 = 0.0029 or 29 ticks

Therefore loss in one contract = $ 12.5 x 29 = $362.50Therefore loss in 6 contract = 362.50 x 6 = $2,175


19/27

The amount deducted (debited) from the account on thattrading day = $2,175.The total account balance now = $9825 (i.e. $12,000 -

$2,175). As the account balance is above the maintenance marginof $8,100, no action is required on this account.Second day after trading settlement price at the end =$0.7009Increase in price of the contract= 0.0034 (34 ticks percontract)Profit on 6 contracts = 12.5x34x6= $2,550

Account balance on the second day = $9825 + $2,550 =$12,375

As the account balance is above the maintenance marginof $8,100, no action is required on this account.

Thi d d ft t di g settlement price at the end= $0 6884


20/27

Third day after trading settlement price at the end= $0.6884Decrease in price of the contract=0.0125 (125 ticks)Loss on 6 contract = 12.5x125x6 = $9,375

Account balance on the third day = $12,375 - $9,375 = $3000Since the account balance is lower than the currentmaintenance margin of $8,100 for six contracts, the customerwill be required to bring in sufficient amount to replenish themargin account to the Initial margin level of $10,938 asVariation margin to continue holding the full six-contractThe amount to be deposited by the customer = $10,938 -$3000 = $7,938In the marking-to- the market process, as the price of theunderlying currency changes, the value of the futurescontract also changes; the resulting change is credited to theparty who gains and debited to the party who loses.

Uses Of Currency Futures


21/27

Uses Of Currency Futures Hedging with currency futures : Currency futures can be usedas an alternative to currency forwards for hedging foreignexchange exposure.

An importer is exposed to foreign exchange risk. He can hedgethis exposure by buying currency futures in the required foreigncurrency for a matching amount and maturity. When an importerbuys currency futures, he is locking in a price for the purchaseof that foreign currency at a future date. Thereby, he iseliminating the effects of exchange rate fluctuations on his foreign

currency dealings. An exporter may also face foreign exchange risk. The exportproceedings in the foreign currency are generally received two orthree months after the business deal is completed. The value ofthe foreign currency may depreciate during this interval and theforeign currency have to be converted to the domestic currency ata lower rate thereby incurring loss on account of exchange ratefluctuations. The risk can be hedged by selling currency futuresin the foreign currency to be received of matching amount andmaturity.

th t t i f h d i i th f t k t


22/27

the strategies for hedging in the currency futures marketcan be stated as follows:When there is likely to be a increase in the price of theunderlying currency, go long by buying the currencyfuture.When there is likely to be a decrease in the price of theunderlying currency, go short on the currency by sellingthe currency future.Imperfections in hedging Firstly, currency futures trading takes place only in alimited number of important currencies such as the Britishpound, Euro, Japanese yen, Mexican peso, Canadiandollar, Swiss franc, etc. In contrast, currency forwards areavailable in most currencies.Secondly, there may be a mismatch between the maturitydate of the currency futures contract and the date ofreceipt or payment of currency in the cash transaction.

Example, the importer may have to make the payment on Sept. 1, but


23/27

p , p y p y p ,the maturity date of the currency future he used to hedge may be thethird Wednesday of September.

Again, the importer may have to make the payment in August, butthere are generally no currency futures expiring in August. Wherethere is a mismatch between the maturity of the cash transaction andthe maturity of the currency futures contract used for hedging the riskin the transaction, it is known as a delta hedge.Thirdly, there may be a mismatch between the size (or amount ofcurrency involved) in the cash transaction and the currency futurescontract. Currency futures are standardised contracts with

predetermined contract sizes for different currencies. The size of thecash transaction is likely to differ from the size of the currency futurescontract.Example, an importer may need 200,000 SF (Swiss Franc) for settlinghis transaction. For hedging this transaction, he would like to buy SFcurrency futures. But the contract size of SF currency futures is

125,000 SFs. A hedge with mismatch in the amount involved is knownas a cross hedge. When there is both maturity and size mismatch, such a hedge isknown as delta cross hedge.

S l ti ith f t


24/27

Speculation with currency futures Speculators may adopt different techniques for speculating.Position trading, spreading and arbitrage are the commonlyused techniques of speculation.

Pos i t ion t rad ing : Position trading involves taking an outrightlong position when the price of the underlying currency isexpected to rise or taking a short position when the price othe underlying currency is expected to fall . These positionsare held only for very short periods; most of the positions areliquidated prior to close of the day Spread t rading: Spread trading is also referred to as straddle.Currency futures in a particular currency maturing in twodifferent months are quoted at different rates. The difference inthe rates is known as intra-currency spread. If the speculatoranticipates that the actual spread in the future would bedifferent from the quoted spread, he may use spread trading togain from such disparity.

b i th d d lli th d


25/27

buying the spread and selling the spreadIn the case of intra-currency spread, the speculator may take along position and a short position in the same currency future butwith different maturity.

He may take a long position in the near month expiry contract(say, March) and a short position in the far month expiry contract(say, June) or vice versa depending upon the expected pricemovements of the currency in the future.If the price of the underlying currency is expected to depreciate

in the future, the speculator may buy the near month currencyfuture and sell the far month currency future.Prior to expiry, he would reverse the respective contracts. Hewould suffer a loss in the near month contract, but the gain in thefar month contract would be greater than the loss.This strategy is known as buying the spread. In the oppositesituation of appreciation in the price of the currency, the strategywould be reversed and would be known as selling the spread.

Currency futures in two different currencies with the same


26/27

Currency futures in two different currencies with the samematurity are obviously quoted two different rates in USdollars.The difference in the rates is known as the inter currencyspread .The actual inter currency spread in the future may differfrom the quoted spread.The speculator may then buy the currency future in onecurrency and simultaneously sell the currency future in theother currency.He will reverse both the contracts before maturity; the lossin one would be covered by the profit in the other deal.

Out of the two currencies involved, he would buy thecurrency future in the currency which is expected toappreciate relative to the other currency in the future.

QUESTIONS


27/27

QUESTIONSWhat is a futures contract?Distinguish between commodity futures and financial futures.What is a currency futures contract?Currency futures are traded in standard sizes which vary fromcurrency to currency and from exchange to exchange. Explain.Describe the methods of settlement of currency futurescontracts.Describe and illustrate how currency futures can be used forhedging foreign exchange risk.Currency futures may not provide perfect hedges. Explain. What is delta hedge?What is position trading?Explain the technique of spread trading as a mechanism forspeculation in currency futures market.Distinguish between intra currency spread and inter currencyspread used for spread trading.

currency futures 2

Documents