C H A P T E R 5
Currency Derivatives

A. Forward Market
B. Currency Futures Market
C. Currency Options Market
D. Currency Call Options
E. Currency Put Options
F. Contingency Graphs for Currency
Options
G. Conditional Currency Options

This chapter will:
A. Explain how forward contracts are used to hedge based on anticipated exchange rate movements
B. Describe how currency futures contracts are used to speculate or hedge based on anticipated exchange rate movements
C. Explain how currency option contracts are used to speculate or hedge based on anticipated exchange rate movements

1. How MNC’s Use Forward Contracts a. Bid/Ask Spread b. Premium or Discount on the Forward Rate c. Arbitrage d. Movements in the Forward Rate over Time e. Offsetting a Forward Contract f. Using Forward Contracts for Swap
Transactions

2. Non-Deliverable Forward Contracts a. New type b. Frequently used for currency in emerging markets c. No delivery required d. One party to the agreement makes a payment to the other party based on the exchange rate at the future date.

1. Contract Specifications
2. Trading Futures
3. Comparison of Currency Futures and Forward Contracts
4. Pricing Currency Futures
5. Credit Risk of Currency Futures
Contracts

6. Speculation with Currency Futures a. Currency Futures Market
Efficiency
If the currency futures market is efficient, the futures price for a currency at any given point in time should reflect all available information.

7. How Firms Use Currency Futures a. Purchasing Futures to Hedge
Payables
Source of Gains from Buying Currency Futures

b. Selling Futures to Hedge
Receivables
8. Closing Out a Futures Position
9. Transaction Costs of Currency
Futures

1. Option Exchanges
2. Over-the-Counter Market

1. Factors Affecting Currency Call
Option Premiums a. Level of existing spot price relative to strike price b. Length of time before the expiration date c. Potential variability of currency

2. How Firms Use Currency Call Options a. Using Call Options to Hedge
Payables b. Using Call Options to Hedge Project
Bidding c. Using Call Options to Hedge Target
Bidding

3. Speculating with Currency Call
Options a. Break-Even Point from
Speculation

1. Factors Affecting Currency Put
Option Premiums
2. Hedging with Currency Put Options
3. Speculating with Currency Put
Options a. Speculating with Combined Put and Call Options b. Currency Options Market
Efficiency

F. Contingency Graphs for
Currency Options
1. Contingency Graph for a Purchaser of a Call Option
2. Contingency Graph for a Seller of a
Call Option
3. Contingency Graph for a Buyer of a
Put Option
4. Contingency Graph for a Seller of a
Put Option

Contingency Graphs for Currency Options
Insert exhibit 5.6 page 123

G. Conditional Currency Options
1. Conditional Premiums
2. When to Choose Conditional Option

Comparison of Conditional and Basic Currency Options
Exhibit 5.7