Currency Futures and Options
Markets
International Finance
Dr. A. DeMaskey
Learning Objectives
What are currency futures contacts? How
are they quoted, valued, and used for
hedging purposes?
 How do currency futures differ from
currency forwards?
 What are currency option contracts? How
are they quoted, valued, and used for
hedging purposes?
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Foreign Currency Derivatives
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Financial management in the 21st century needs to
consider the use of financial derivatives
These derivatives, so named because their values
are derived from the underlying asset, are a
powerful tool used for two distinct management
objectives:
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Speculation
Hedging
Foreign Currency Derivatives
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In the wrong hands, derivatives can cause a
corporation to collapse (Barings, Allied Irish
Bank), but used wisely they allow a financial
manager the ability to plan cash flows
The financial manager must first understand the
basics of the structure and pricing of these tools.
The derivatives that will be discussed are:
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Foreign Currency Futures
Foreign Currency Options
Foreign Currency Futures

A foreign currency futures contract is an
alternative to a forward contract.
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It calls for future delivery of a standard amount
of currency at a fixed time and price.
These contracts are traded on exchanges with
the largest being the International Monetary
Market located in the Chicago Mercantile
Exchange.
Contract Specifications
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Contract size
Method of stating
exchange rate
Maturity dates
Last trading date
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Collateral and
maintenance margin
Settlement
Commission
Clearing Operations
Using Foreign Currency
Futures
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Hedging
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Speculating
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Forward-Futures Arbitrage
Profit or Loss from a Long
Futures Hedge
Profit or Loss from a Short
Futures Hedge
Forward Contracts versus
Futures Contracts
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Trading
Regulation
Frequency of delivery
Size of contract
Delivery date
Settlement
Pricing
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Quotes
Transaction costs
Collateral
Credit risk
Clearing Operation
Location
Liquidity
Foreign Currency Options
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A foreign currency option is a contract
giving the option holder the right, but not
the obligation, to buy or sell a given amount
of foreign exchange at a fixed price per unit
for a specified time period.
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Call Option vs. Put Option
Holder vs. Grantor
Foreign Currency Options
Terminology
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Every option has three
different price
elements
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Strike or exercise price
Option premium
The underlying or
actual spot rate in the
market
There are two types of
option maturities
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American options
European options
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Options may also be
classified as per their
payouts
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At-the-money
In-the-money (ITM)
Out-of-the-money
(OTM) options
Market Structure
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Over-the-Counter (OTC) Market
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Main advantage is that they are tailored to purchaser
Counterparty risk exists
Mostly used by individuals and banks
Organized Exchanges
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The Chicago Mercantile
Philadelphia Stock Exchange
Options Clearinghouse Corporation (OCC)
Using Foreign Currency
Options
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Users
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Financial Firms
Corporations
Hedging
 Speculating
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Protecting Against the Potential
Appreciation of a Currency
Using a Call Option
Protecting Against the Potential
Depreciation of a Currency
Using a Put Option
Option Pricing and Valuation
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An option’s value consists of two parts:
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Intrinsic Value
Time Value
Intrinsic Value is the amount by which an
option is in-the-money.
 Time Value is the amount by which an
option’s value exceeds its intrinsic value.
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Option Pricing Model
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The value of a currency option depends on
the following five variables:
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Strike price relative to the spot exchange rate
Time to maturity
Relative interest rates between the two
currencies
Volatility of underlying currency
Supply and demand for specific option
Online Application
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Visit the Commodity Futures Trading Commission at
http://www.cftc.gov/.
The Options Clearing Corporation at
http://www.optionsclearing.com/
The Chicago Mercantile Exchange provides current and
historical futures and option prices at
http://www.cme.com/prices/index.cfm.
The Chicago Board Options Exchange at
http://www.cboe.com, and
The London International Financial Futures and
Options Exchange at www.liffe.com.