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LEARNING OUTCOMES
❖Understand
the
characteristics
of
the
forward market, future markets and options
markets.
Chapter 3
❖Use forward, future and option contracts to
hedge or speculate
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CURRENCY DERIVATIVES
Base and Quote currencies
FORWARD MARKET
CURRENCY FUTURES MARKET
3.
CURRENCY OPTIONS MARKET
❖What is Forex? | FXTM Learn Forex in 60 Seconds (youtube.com)
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1. FORWARD MARKET
1. FORWARD MARKET
The forward market facilitates the trading of forward
❖The parties are bound by the contract and are
contracts on currencies. A forward contract is an
responsible for fulfilling their contractual obligations
agreement between a corporation and a commercial
❖The most common forward contracts are for 30,
bank to exchange a specified amount of a currency
60, 90, 180, and 360 days, although other periods
at a specified exchange rate (called the forward
(including
longer
periods)
are
available
rate) on a specified date in the future
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1. FORWARD MARKET
1. FORWARD MARKET
Forward Rate:
Forward Rate:
➢Formula to calculate bid rate (tỷ giá MUA):
- Used to lock in exchange rate at which they can
buy or sell foreign currencies.
R − R2 
Fb = Sb + Sb  1
n
 N 
- It depends on:
• Spot rate
Fb: Forward Bid exchange rate
▪Period
Sb: Spot Bid exchange rate
• Interest rate of involving currency
n: period
N: number of a period
R1: deposit interest rate of quote currency
R2: loan interest rate of commodity currency
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1. FORWARD MARKET
1. FORWARD MARKET
Forward Rate:
Example
➢Formula to calculate ask rate (tỷ giá BÁN): :
Trong đó:
➢Customer C wants to sell 20,000 EUR from an export contract in next three
months,
R − R2 
Fa = Sa + Sa  1
n
 N 
➢Customer D needs to buy 25,000 EUR to pay for next 6 months
➢Spot rate EUR / VND is equal to 25,940 / 26,018
➢Interest rates for EUR and VND as follows:
Fb: Forward Ask exchange rate
Currency
Sb: Spot Ask exchange rate
3 months period
Deposit
n: period
N: number of a period
R1: loan interest rate of quote currency
6 months period
Loan
Deposit
Loan
EUR (% per year)
3.25
4.25
3.28
4.32
VND (% per year)
7.2
9
7.8
10.2
1. Determine the 3-month forward buying rate to offer customers C
R2: deposit interest rate of commodity currency
2. Determine the 6-month forward ask rate to offer customers D
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1. FORWARD MARKET
Hedging for Payable:
❖Application of Forward market:
❖Payable: Payment for importing by foreign currency .
→Importer: Buys foreign currency in future, be gotten risk
Hedging:
when future spot rate (S’) higher (>) currently spot
rate (S).
❑Payable in import operation
→Hedging strategy: Sign the buying Forward contract
❑Receivables in export operation
❑Investment in foreign currency
Payment for
importing
Sign the buying
Forward
Contract
❑Loan in foreign currency
Spot’
Spot
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Buy Foreign Currency
Buy
Forward
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Hedging for Receivable:
1. FORWARD MARKET
❖Receivable: Receive foreign currency from exporting.
❖Application of Forward market:
→Exporter: sells foreign currency in future, be gotten
➢Speculation/ Đầu cơ
risk when future spot rate (S’) lower (<) currently
If the trader expects a strong appreciation of
spot rate (S).
currency in the future.
→Hedging strategy: Sign the selling Forward contract
➢→ speculation by buying forward contract of that
currency.
Receive from
exporting
Spot
Sign the Selling Forward
Contract
Spot’
in the future.
Sell
Forward
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➢If the trader expects a strong devaluation of currency
Sell Foreign Currency
➢→ speculation by selling the forward contract of that
currency.
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2. Currency Futures Market
2. Currency Futures Market
❖Concept:
Future contracts were created to overcome 3 issues
Currency
futures
contracts
are
specifying a standard volume of a particular
Why do we have
future contract?
❖Difficulties in finding transaction partners.
currency to be exchanged on a specific settlement
❖The risk of partner does not perform the contract
date.
❖Difficult to remove contractual obligations.
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of forward contracts:
contracts
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2. Currency Futures Market
2. CURRENCY FUTURES MARKET
Trading mechanism and payment process
❖Feature:
➢Standardized
contract:
contract
size,
➢Margin Mechanism
price,
delivery month, delivery date …
➢Daily payment mode
➢Traded currencies on the floor
➢Mechanism of Final settlement
➢Can remove contract obligations easily
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MARGIN
DAILY PAYMENT MODE
❖Initial margin: Amount of money need to have to
❖Example
open future market.
❖Variation margin :
BUY EUR FUTURES CONTRACT
➢Minimum amount of money need to maintain on
Date
10/11/2006
the following days.
Delivery month
06/2007
Exchange rate
1.253 EUR/USD
➢Minimum amount of money before investor
Contract scale
EUR 125,000
offered margin call
Initial margin
1.5% contract value
Variation margin
USD 2,000
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DAILY PAYMENT MODE
Deposit/
Withdrawal
amount
Balance at
the end of
the day
Date
1/1/2010
2349.375
2349.375
Delivery month
09/2010
62.5
2411.875
Exchange rate
1.5088 GBP/USD
25
2436.875
Contract scale
GBP 62,500
156,837.5
125
2561.875
Initial margin
USD 1,755
156,750
(87.5)
2474.375
Variation margin
1.2538
156,725
(25)
2449.375
USD 1,300
17/11/2006
1.2550
156,875
150
2599.375
20/11/2006
1.2545
156,812.5
(62.5)
Settlement
price
Contract
value
Sign contract
1.2530
156,625
10/11/2006
1.2535
156,687.5
13/11/2006
1.2537
156,712.5
14/11/2006
1.2547
15/11/2006
1.2540
16/11/2006
Date
Profit/loss
Buy GBP futures contracts
(2536.875)
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DAILY PAYMENT MODE
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DAILY PAYMENT MODE
Contract
value
Deposit/
withdraw
amount
Account
balance at
the end of
the day
Date
Payment
price
Sign contract
1.5088
➢If a person is in long position (buyer) of a futures
01/01/2010
1.5076
contract, he can close this position by reselling the
02/01/2010
1.5045
03/01/2010
1.5010
04/01/2010
1.5006
➢If a person is in a short position (seller) of a
05/01/2010
1.5050
futures contract, he can close this position by
08/01/2010
1.5072
09/01/2010
1.5091
Loss/ profit
until maturity.
contract in the market.
buying a contract in the market.
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MECHANISM OF FINAL SETTLEMENT
Case 1: Future contracts are not maintained
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MECHANISM OF FINAL SETTLEMENT
2. CURRENCY FUTURES MARKET
Case 2: Future contracts are maintained until
Application:
maturity:
❖Speculation
❖The buyer will resell the future contract to the
❖Hedging
clearing company, the amount of money to buy will
be bought in the spot market.
❖The seller will repurchase the futures contract from
the clearing company, the money will be sold on the
spot market.
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3. Currency Options Market
❖ Concept:
Currency option
➢Currency options provide the right to purchase or
sell currencies at specified prices.
❖ European and American style options:
➢European style: Only allow the option to be
exercised at the time of maturity.
➢American style: Allows the option to be exercised
at any time until the contract is due.
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Currency call option
Currency put option
Provide the
right to
purchase
currencies at
specified prices
Provide the
right to sell
currencies at
specified prices
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Currency Call Option
Quyền chọn mua
Buyer - Bên mua
→ Obligation: Pay
option fees.
→ Right: Buy a
certain currency at
a specified price
3.1 Call Option
Buy Foreign
Currency
Buy Call Option Currency
(Right to buy Currency in Spot
the Future)
→ Right: Receive
option fees.
→ Obligation: Sell a
certain currency at a
specified price, if the
buyer exercises his
rights
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Spot’
Seller - Bên bán
Call Option Currency
Payment for
Importing
Exercise the
Right
Exercise Price: Exchange rate
Premium: Fee per unit
Spot’ > Exercise → buy at Exercise → Cost = Exercise + Premium
Spot’ < Exercise → buy at Spot’ → Cost = Spot’ + Premium
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Call Option Currency:
Buyer wants to buy foreign currency
Spot’
Call Option Currency:
Buyer wants to buy foreign currency
Spot’
Exercise
Exercise
Spot’
Buyer:
Spot’ > Exercise → Choose Exercise → exercises right to buy
Spot’ > Exercise → Buyer buys currency at the
Exercise price or exercises the Call option
Cost of buyer = Exercise + Premium
Spot’ > Exercise → Choose Exercise → exercises right to buy
The Seller has to sell currency at the Exercise price and
buy back currency at the Spot’ rate
Profit/Loss of Seller = Exercise - Spot’+ Premium
Profit/Loss of Buyer = Spot’ - Exercise - Premium
(+)
(-)
(-)
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Premium > Exercise – Spot’ → seller earns Profit, and versa
Spot’ - Exercise > Premium → Buyer earns Profit, and versa
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Spot’
Buyer:
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Call Option Currency:
Buyer wants to buy foreign currency
Call Option Currency:
Buyer wants to buy foreign currency
Exercise
Exercise
Spot’
Buyer:
Spot’
Spot’
Buyer:
Spot’ < Exercise. → Choose Spot’ → buy currency at Spot’
rate
Spot’ < Exercise → Buyer buys a currency at the Spot’
price or does not exercise the Call option
Cost of buyer = Spot’ + Premium
Loss = - Premium
The Buyer will buy at the Spot’ rate with or without the
Call option, therefore he only loses in this case.
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Spot’ < Exercise. → Choose Spot’ → buy currency at Spot’
rate
Spot’ < Exercise → Buyer buys a currency at the Spot’
price → Seller does not have to sell currency
Profit of Seller = + Premium
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Spot’
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3. Currency Options Market
3. Currency Options Market
❖Option rate
❖In call option contract:
❖Net profit receiving in buy call option
Call option contract
Net profit = Spot rate – Premium paid for call option
Call option rate is applied to buy foreign currency
– Purchase price
➢ Call option rate is smaller than spot rate =>
Net profit receiving in sell call option
apply Call option
Net profit = Premium paid for call option - Spot rate
➢Call option rate is larger than spot rate => not
+ Purchase price
apply Call option
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Example 1
Example 2
❖You purchased a call option on British pounds for a
❖You sold a call option on British pounds for a premium
premium of $0.045 per unit with an exercise price
of $0.045 per unit with an exercise price of $4.98. The
of $4.98. The option will not be exercised until the
option will not be exercised until the expiration date, if
expiration date, if at all. If the spot rate on the
at all. If the spot rate on the expiration date is $5.17,
expiration date is $5.17, calculate your net profit or
calculate your net profit or loss per unit.
loss per unit.
❖You sold a call option → you are Seller.
❖You purchased a call option → you are buyer.
❖Spot’ rate > Exercise price → Buyer buys at Exercise
❖Spot’ rate > Exercise price → buy at Exercise price
price → Seller sells at Exercise
❖Profit/Loss = Spot’ – Exercise - Premium
❖Profit/Loss of Seller = Exercise – Spot’ + Premium
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3.2 Put Option
Currency Put Option
Quyền chọn bán
Buyer - Bên mua
→ Obligation: Pay
option fees.
→ Right: Sell a
certain currency at
a specified price
Seller - Bên bán
→ Right: Receive
option fees.
Put Option Currency
S
S’
Receive from
exporting
Exercise the Right
Exercise Price: Exchange rate
Premium: Fee per unit
→ Obligation: Buy
a certain currency at
the price determined
if the buyer exercises
his right
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Buy Put Option Currency
(Right to Sell Currency in
the Future)
Sell Foreign Currency
Spot’ < Exercise → Sell at Exercise → Receive = Ex - Premium
Spot’ > Exercise → sell at Spot’ → Receive = Spot’ - Premium
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Put Option Currency:
Buyer wants to sell foreign currency
Put Option Currency:
Buyer wants to sell foreign currency
Exercise
Buyer:
Exercise
Spot’
Spot’
Buyer:
Spot’ < Exercise → Choose Exercise → exercises right to sell
Spot’ < Exercise → The Buyer sells currency at the
Exercise price or exercises the Put option
Receive of buyer = Exercise - Premium
Profit/Loss of Buyer = Exercise - Spot’ - Premium
(+)
Spot’
Spot’ < Exercise → Choose Exercise → exercises right to sell
The Seller has to buy currency at the Exercise price and
sell back currency at the Spot’ rate
Profit/Loss of Seller = Spot’ - Exercise + Premium
(-)
(-)
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Premium > Spot’ - Exercise → seller earns Profit, and versa
Exercise - Spot’ > Premium → Buyer earns Profit, and versa
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Spot’
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Put Option Currency:
Buyer wants to sell foreign currency
Spot’
Put Option Currency:
Buyer wants to sell foreign currency
Spot’
Exercise
Exercise
Spot’
Buyer:
Spot’ > Exercise → Choose Spot’ → Sell currency at Spot’
rate
Spot’ > Exercise → Buyer sells currency at the Spot’
rate or does not exercise the Put option
Receive of buyer = Spot’ - Premium
Loss of Buyer = - Premium
Buyer will sell at the Spot’ rate with or without the Put
option, therefore he only loses in this case.
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Buyer:
Spot’
Spot’ > Exercise → Choose Spot’ → Sell currency at Spot’
rate
Spot’ > Exercise → Buyer sells a currency at the Spot’
price → Seller does not have to buy currency
Profit of Seller = + Premium
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3. Currency Options Market
3. Currency Options Market
❖Option rate
❖In put option contract:
Put option contract (chọn bán):
❖Net profit receiving in buy put option (mua quyền
Put option rate is applied to sell foreign currency
chọn bán)
Net profit = Purchase price (giá thực hiện)- Spot rate
➢Put option rate is smaller than spot rate => not
- Premium paid for put option
apply Put option
❖Net profit receiving in sell put option (bán quyền
➢Put option rate is larger than spot rate => apply
chọn bán)
Put option
Net profit = Premium paid for put option + Spot rate
- Purchase price
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Example 3
Example 4
❖You purchased a put option on British pounds for a
❖You sold a put option on British pounds for a premium
premium of $0.045 per unit with an exercise price
of $0.045 per unit with an exercise price of $4.98. The
of $4.98. The option will not be exercised until the
option will not be exercised until the expiration date, if
expiration date, if at all. If the spot rate on the
at all. If the spot rate on the expiration date is $5.17,
expiration date is $5.17, calculate your net profit or
calculate your net profit or loss per unit.
loss per unit.
❖You sold a put option → you are Seller.
❖You purchased a put option → you are buyer.
❖Spot rate > Exercise price → Buyer sells at Spot price
❖Spot rate > Exercise price → sell at Spot price
→ Seller does not buy
❖Profit/Loss = - Premium
❖Profit/Loss of Seller = + Premium
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3. Currency Options Market
3. Currency Options Market
❖Information about USD/VND option price as
On December 5th, customer A bought a call option and
customer B bought an put option.
follow:
1. Calculate the premium that the bank earned from
Content
Call option
Put option
Value of the contract
100,000 USD
100,000 USD
Purchase price
20,830
20,850
Period
3 months
3 months
options to earned profit?
Style option
US
US
3. Assuming that the USD / VND exchange rate is 20,890
Premium
10 dong /USD
20 dong /USD
on the due date, how much profit or loss will customers
selling the option contracts to customers A and B?
2. How does the exchange rate of USD / VND in the
market change that leads customers A and B will exercise
get?
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