Currency Futures and Currency Futures and Options MarketsOptions Markets
Chapter 7Chapter 7
22
PART I.PART I.FUTURES CONTRACTSFUTURES CONTRACTS
I.I. CURRENCY FUTURESCURRENCY FUTURESA.A. BackgroundBackground
1.1. Long historyLong history2.2. Extremely volatile due Extremely volatile due
to to information driven information driven naturenature
3.3. Price Discovery RolePrice Discovery Role
33
FUTURES CONTRACTSFUTURES CONTRACTS
B.B. 1972: Chicago Mercantile1972: Chicago MercantileExchange opens theExchange opens the
International Monetary International Monetary Market. Market. (IMM)(IMM)
Purpose: Purpose:
44
FUTURES CONTRACTSFUTURES CONTRACTS
2.2. IMM providesIMM providesa.a. an outlet for hedging currencyan outlet for hedging currencyrisk with futures contracts.risk with futures contracts.Definition:Definition:contracts written requiring contracts written requiring 1. 1. standard quantitystandard quantity of an of an available available currencycurrency22. . at a at a fixed exchange ratefixed exchange rate 3. at a 3. at a set delivery date.set delivery date.
55
FUTURES CONTRACTSFUTURES CONTRACTS
b.b. Available Futures Currencies/Contract Available Futures Currencies/Contract Size: (p. 211)Size: (p. 211)
1.) British pound1.) British pound / 62,500/ 62,500
2.) Canadian dollar /100,0002.) Canadian dollar /100,000
3.) Euro / 125,0003.) Euro / 125,000
4.) Swiss franc / 4.) Swiss franc / 125,000125,000 5.) 5.) Japanese yen / 12.5 millionJapanese yen / 12.5 million
6.) Mexican peso / 500,0006.) Mexican peso / 500,000
7.) Australian dollar / 100,0007.) Australian dollar / 100,000
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FUTURES CONTRACTSFUTURES CONTRACTS
c.c. Transaction costs:Transaction costs:
commission payment to a floor commission payment to a floor trader trader
d.d. Leverage is highLeverage is high1.)1.) Initial margin required isInitial margin required is
relatively low (less than 2% relatively low (less than 2% ofof
contract value).contract value).
77
ADAD BPBP CDCD ECEC JYJY MPMP SFSF
SizeSize 100,100,
00000062,62,
500500100,100,
000000125,125,
00000012,12,
500,500,
000000
500,500,
000000125,125,
000000
IMIM 1,481,4855
1,3501,350 608608 2,022,0255
2,022,0255
3,123,1255
1,451,4522
MMMM 1,101,1000
1,0001,000 450450 1,501,5000
1,501,5000
2,502,5000
1,071,0755
TradTradee
MarcMarchh
JuneJune SeptSept DecDec
HrsHrs 7:207:20 AMAM ToTo 2:002:00 PMPM
P.21P.2111
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FUTURES CONTRACTS: FUTURES CONTRACTS: SAFEGUARDSSAFEGUARDS
e.e. What are the safeguards?What are the safeguards?
1.)1.) Contracts set to a daily priceContracts set to a daily price
limit restricting maximum limit restricting maximum daily price movements.daily price movements.
2.)2.) If limit is reached, a If limit is reached, a marginmargin
callcall may be necessary to may be necessary to maintain a minimum maintain a minimum
margin.margin.
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FUTURES CONTRACTS: FUTURES CONTRACTS: SAFEGUARDSSAFEGUARDS
3.)3.) Marking to MarketMarking to Market
4.) Eliminating default4.) Eliminating default
5.) Delivery cancelled5.) Delivery cancelled
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FUTURES CONTRACTSFUTURES CONTRACTS
g.g. Global futures exchanges:Global futures exchanges:1.)1.) I.M.M. International Monetary I.M.M. International Monetary MarketMarket2.)2.) L.I.F.F.E.London International L.I.F.F.E.London International Financial Futures ExchangeFinancial Futures Exchange3.)3.) C.B.O.T. Chicago Board of TradeC.B.O.T. Chicago Board of Trade4.) 4.) S.I.M.E.X.Singapore InternationalS.I.M.E.X.Singapore International
Monetary ExchangeMonetary Exchange5.)5.) D.T.B. Deutsche Termin BourseD.T.B. Deutsche Termin Bourse6.)6.) H.K.F.E. Hong Kong Futures H.K.F.E. Hong Kong Futures
ExchangeExchange
1111
FUTURES CONTRACTS FUTURES CONTRACTS (p.214)(p.214)
B.B. Forward vs. Futures ContractsForward vs. Futures ContractsBasic differences:Basic differences:1. Trading Locations1. Trading Locations 6. Quotes6. Quotes2. Regulation2. Regulation 7. Margins7. Margins3. Frequency of 3. Frequency of 8. Credit risk8. Credit risk deliverydelivery 4. Size of contract 4. Size of contract 5. Transaction Costs5. Transaction Costs
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FUTURES CONTRACTS: FUTURES CONTRACTS: Why would you use Why would you use them?them?Advantages of Advantages of
futures:futures:*1.)*1.) High High
leverage(2%)leverage(2%)
2.) Easy liquidation2.) Easy liquidation
3.) Well- organized 3.) Well- organized and stable and stable
market.market.
Disadvantages of Disadvantages of futures:futures:
1.) Limited to 71.) Limited to 7
currenciescurrencies
2.) Limited dates 2.) Limited dates
of deliveryof delivery
3.) Rigid contract3.) Rigid contract
sizes.sizes.
CURRENCY CURRENCY OPTIONSOPTIONS
PART IIPART II
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CURRENCY OPTIONSCURRENCY OPTIONS
I.I. OPTIONSOPTIONS
A.A. Currency options Currency options 1.1. offer another product to offer another product to
hedge exchange rate risk.hedge exchange rate risk.
2.2. first offered on first offered on PhiladelphiaPhiladelphia
Exchange (PHLX).Exchange (PHLX).
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CURRENCY OPTIONSCURRENCY OPTIONS
BuyersBuyers Sellers=WritersSellers=Writers
Buy Sell Buy Sell
CALL
PUT
Premium
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CURRENCY OPTIONSCURRENCY OPTIONS
4. Definition:4. Definition:
a contract from a writer ( the seller) a contract from a writer ( the seller) that gives that gives
a.a. the right not the obligationthe right not the obligation to the to the holder holder (the buyer)(the buyer) to buy or sell to buy or sell
b.b. a standard a standard amount of amount of an an available available currency at currency at
c.c. a fixed exchange rate for a fixed timea fixed exchange rate for a fixed timeperiod.period.
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CURRENCY OPTIONSCURRENCY OPTIONS
5.5. Two Types: Expiration Dates of Two Types: Expiration Dates of Currency Currency OptionsOptions
a.a. AmericanAmerican
exercise date may occur anyexercise date may occur anytime up to the expiration date.time up to the expiration date.
b.b. EuropeanEuropean
exercise date occurs only at exercise date occurs only at the expiration date and not the expiration date and not before.before.
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CURRENCY OPTIONSCURRENCY OPTIONS
7.7. Exercise Price (exchange Exercise Price (exchange rate)rate)
a. a. Sometimes known as theSometimes known as the
strike price.strike price.
B.B. The exchange rate at The exchange rate at which the option holder which the option holder can can buy or sell the buy or sell the contracted currency.contracted currency.
1919
CURRENCY OPTIONSCURRENCY OPTIONS
c.c. Types of Currency Types of Currency Options Options (whether (whether you can you can buy or sell):buy or sell):
1.)1.) CallsCalls
2.)2.) PutsPuts
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CURRENCY OPTIONSCURRENCY OPTIONS
8.8. Status of an optionStatus of an optiona.a. In-the-moneyIn-the-money
Call:Call: Spot > strikeSpot > strikePut:Put: Spot < strikeSpot < strike
b.b. Out-of-the-moneyOut-of-the-moneyCall:Call: Spot < strikeSpot < strikePut:Put: Spot > strikeSpot > strike
c.c. At-the-moneyAt-the-moneySpot = the strikeSpot = the strike
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CURRENCY OPTIONSCURRENCY OPTIONS
9.9. What is the premium:What is the premium: the the price of an option that the price of an option that the writer charges the buyer.writer charges the buyer.
2222
CURRENCY OPTIONSCURRENCY OPTIONS
B.B. Why Use Currency Options?Why Use Currency Options?1.1. For the firm hedging foreignFor the firm hedging foreign
exchange risk withexchange risk with
Future event is very uncertainFuture event is very uncertaingains.gains.
2.2. For speculatorsFor speculators- profit from favorable - profit from favorable
exchange rate changes. exchange rate changes.
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CURRENCY OPTIONSCURRENCY OPTIONS
C. Using Forward or Futures ContractsC. Using Forward or Futures Contracts
Forward or futures contracts areForward or futures contracts aremore suitable for hedging a more suitable for hedging a
knownknown amount of foreign currency amount of foreign currency flow.flow.
Examples: accounts payable/recExamples: accounts payable/rec
2424
Options Sample Options Sample ProblemsProblems
Ford buys a Franc put Ford buys a Franc put option (contract size: option (contract size: FF250,000) at a premium of FF250,000) at a premium of $.01/FF. If the exercise $.01/FF. If the exercise price is $.21 and the spot at price is $.21 and the spot at expiration is $.216, what is expiration is $.216, what is Ford’s profit (loss)?Ford’s profit (loss)?
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SOLUTIONSOLUTION
REVENUES: REVENUES: Sell at .21Sell at .21
COSTS:COSTS: If exercisedIf exercised
Buy at Buy at .216.216
Premium + Premium + .01.01
TotalTotal .226.226
Loss: If exercised:Loss: If exercised: $4,000$4,000
Loss: If not exercised: Loss: If not exercised: $2,500$2,500
(the original premium)(the original premium)