CHAPTER 6
CURRENCY
FUTURES AND
OPTIONS MARKETS
CHAPTER OVERVIEW
I.
II.
FUTURES CONTRACTS
CURRENCY OPTIONS
PART I.
FUTURES CONTRACTS
I. CURRENCY FUTURES
A. Background
1. 1972: Chicago Mercantile
Exchange opens
International Monetary
Market. (IMM)
FUTURES CONTRACTS
2. IMM provides
a. an outlet for hedging
currency risk with futures
contracts.
b. Definition:
contracts written requiring a
standard quantity of an available
currency at a fixed exchange rate
at a set delivery date.
FUTURES CONTRACTS
c.
Available Futures Currencies:
1.) British pound
5.) French franc
2.) Canadian dollar
3.) German mark
4.) Swiss franc
6.) Japanese yen
7.) Australian
dollar
FUTURES CONTRACTS
d. Standard Quantity of Currency
contract quantity sizes differ for
each of the 7 available
currencies.
Example
German mark = DM125,000
FUTURES CONTRACTS
e.
f.
Transaction costs:
payment of commission to a
trader
Leverage is high
1.) Initial margin required is
relatively low (less than 2%
of contract value).
FUTURES CONTRACTS
g.
Maximum price movements
1.) Contracts set to a daily
price
limit restricting maximum
daily price movements.
FUTURES CONTRACTS
2.) If limit is reached, a margin
call may be necessary to
maintain a minimum margin.
FUTURES CONTRACTS
h.
Global futures exchanges:
1.)
I.M.M. International Monetary
Market
2.)
L.I.F.F.E.London International
Financial Futures Exchange
3.)
C.B.O.T. Chicago Board of Trade
FUTURES CONTRACTS
4.)
S.I.M.E.X.Singapore International
Monetary Exchange
5.)
D.T.B. Deutsche Termin Bourse
6.)
H.K.F.E. Hong Kong Futures Exchange
FUTURES CONTRACTS
B. Forward vs. Futures Contracts
Basic differences:
1. Trading Locations
6. Settlement Date
2. Regulation
3. Frequency of
delivery costs
4. Size of contract
5. Delivery dates
7. Quotes
8. Transaction
9. Margins
10. Credit risk
FUTURES CONTRACTS
Advantages of
futures:
1.) Smaller
contract size
2.) Easy
liquidation
3.) Wellorganized
and stable
market.
Disadvantages of
futures:
1.) Limited to 7
currencies
2.) Limited dates
of delivery
3.) Rigid contract
sizes.
PART II
CURRENCY OPTIONS
I. OPTIONS
A. Currency options
1. offer another method to
hedge exchange rate risk.
2. first offered on Philadelphia
Exchange (PHLX).
3. fastest growing segment of
the hedge markets.
CURRENCY OPTIONS
4. Definition:
a contract from a writer ( the
seller) that gives the right not
the obligation to the holder (the
buyer) to buy or sell a standard
amount of an available
currency at a fixed exchange
rate for a fixed time period.
CURRENCY OPTIONS
5. Types of Currency Options:
a. American
exercise date may occur any
time up to the expiration date.
b. European
exercise date occurs only at the
expiration date.
CURRENCY OPTIONS
7. Exercise Price
a. Sometimes known as the
strike price.
b. the exchange rate at
which the option holder
can buy or sell the
contracted currency.
CURRENCY OPTIONS
8.
Status of an option
a. In-the-money
Call: Spot > strike
Put: Spot < strike
b.
Out-of-the-money
Call: Spot < strike
Put: Spot > strike
c.
At-the-money
Spot = the strike
CURRENCY OPTIONS
9. The premium: the price of an
option that the writer charges
the buyer.
CURRENCY OPTIONS
B. Using Currency Options
1. For the firm hedging foreign
exchange risk
a. With sizable unrealized gains.
b. With foreign currency flows
forthcoming.
CURRENCY OPTIONS
2. For speculators
- profit from favorable
exchange rate changes.
CURRENCY OPTIONS
C. Option Pricing and Valuation
1. Value of an option equals
a. Intrinsic value
b. Time value
CURRENCY OPTIONS
2. Intrinsic Value
the amount in-the-money
3. Time Value
the amount the option is in
excess of its intrinsic value.
CURRENCY OPTIONS
4.
Other factors affecting the
value of an option
a. value rises with longer
time to expiration.
b. value rises when greater
volatility in the exchange
rate.
CURRENCY OPTIONS
5.
Value is complicated by both
the home and foreign interest
rates.
CURRENCY OPTIONS
D.
Using Forward or Futures
Contracts:
Forward and futures contracts
are more suitable for hedging a
known amount of foreign
currency flow.
CURRENCY OPTIONS
E.
Market Structure
1. Location
a. Organized Exchanges
b. Over-the-counter
1.) Two levels
retail and wholesale