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    RMT Lecture Notes

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    Abid
    This document discusses currency derivatives, including forward contracts, futures contracts, and options contracts. It explains that forward contracts lock in an exchange rate for a future date, while futures contracts standardize the currency amount and date. It also describes how currency futures and options can be used for hedging currency risk or speculation based on exchange rate expectations. The key differences between forward and futures markets are standardized contract sizes and delivery dates in futures markets versus customized terms in forward markets.

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    RMT Lecture Notes

    Uploaded by

    Abid
    168 views13 pages
    This document discusses currency derivatives, including forward contracts, futures contracts, and options contracts. It explains that forward contracts lock in an exchange rate for a future date, while futures contracts standardize the currency amount and date. It also describes how currency futures and options can be used for hedging currency risk or speculation based on exchange rate expectations. The key differences between forward and futures markets are standardized contract sizes and delivery dates in futures markets versus customized terms in forward markets.

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    This document discusses currency derivatives, including forward contracts, futures contracts, and options contracts. It explains that forward contracts lock in an exchange rate for a future date, while futures contracts standardize the currency amount and date. It also describes how currency futures and options can be used for hedging currency risk or speculation based on exchange rate expectations. The key differences between forward and futures markets are standardized contract sizes and delivery dates in futures markets versus customized terms in forward markets.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    168 views13 pages

    RMT Lecture Notes

    Uploaded by

    Abid
    This document discusses currency derivatives, including forward contracts, futures contracts, and options contracts. It explains that forward contracts lock in an exchange rate for a future date, while futures contracts standardize the currency amount and date. It also describes how currency futures and options can be used for hedging currency risk or speculation based on exchange rate expectations. The key differences between forward and futures markets are standardized contract sizes and delivery dates in futures markets versus customized terms in forward markets.

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    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    of 13

    Chapter

    5
    Currency Derivatives

    Chapter Objectives

    To explain how forward contracts are used


    for hedging based on anticipated
    exchange rate movements; and
    To explain how currency futures contracts
    and currency options contracts are used
    for hedging or speculation based on
    anticipated exchange rate movements.

    Forward Market
    A forward contract is an agreement
    between a firm and a commercial bank to
    exchange a specified amount of a currency
    at a specified exchange rate (called the
    forward rate) on a specified date in the
    future.
    Forward contracts are often valued at $1
    million or more, and are not normally used
    by consumers or small firms.

    Forward Market
    When MNCs anticipate a future need for or
    future receipt of a foreign currency, they can
    set up forward contracts to lock in the
    exchange rate.
    The % by which the forward rate (F )
    exceeds the spot rate (S ) at a given point in
    time is called the forward premium (p ).
    F = S (1 + p )

    F exhibits a discount when p < 0.

    Forward Market
    A swap transaction involves a spot
    transaction along with a corresponding
    forward contract that will reverse the spot
    transaction.
    A non-deliverable forward contract (NDF)
    does not result in an actual exchange of
    currencies. Instead, one party makes a net
    payment to the other based on a market
    exchange rate on the day of settlement.

    Currency Futures Market


    Currency futures contracts specify a
    standard volume of a particular currency to
    be exchanged on a specific settlement
    date.
    They are used by MNCs to hedge their
    currency positions, and by speculators who
    hope to capitalize on their expectations of
    exchange rate movements.

    Currency Futures Market


    The contracts can be traded by firms or
    individuals through brokers on the trading
    floor of an exchange (e.g. Chicago
    Mercantile Exchange), automated trading
    systems (e.g. GLOBEX), or the over-thecounter market.
    Brokers who fulfill orders to buy or sell
    futures contracts typically charge a
    commission.

    Comparison of the Forward & Futures


    Markets
    Forward Markets
    Futures Markets
    Contract size

    Customized

    Delivery date
    Participants

    Customized
    Banks, brokers,

    Standardized
    Banks, brokers,

    Security

    Compensating

    Small security

    Clearing

    Handled by

    MNCs. Public MNCs. Qualified


    speculation notpublic speculation
    encouraged.
    encouraged.
    deposit
    bank balances or
    credit lines needed.
    operation
    individual banks
    & brokers.
    clearinghouse.
    Daily settlements
    to market prices.

    deposit required.

    Handled by
    exchange

    Standardized

    Comparison of the Forward & Futures


    Markets
    Forward Markets
    Futures Markets
    Marketplace

    Worldwide
    telephone
    network

    Central exchange
    floor with worldwide
    communications.

    Regulation

    Self-regulating

    Commodity

    Liquidation

    Mostly settled by

    Mostly settled by

    Transaction

    Banks bid/ask

    Negotiated

    Futures Trading
    Commission,
    National Futures
    Association.
    actual delivery.
    Costs

    offset.

    spread.

    brokerage fees.

    Currency Futures Market


    Enforced by potential arbitrage activities,
    the prices of currency futures are closely
    related to their corresponding forward rates
    and spot rates.
    Currency futures contracts are guaranteed
    by the exchange clearinghouse, which in
    turn minimizes its own credit risk by
    imposing margin requirements on those
    market participants who take a position.

    Currency Options Market


    Currency options provide the right to
    purchase or sell currencies at specified
    prices. They are classified as calls or puts.
    Standardized options are traded on
    exchanges through brokers.
    Customized options offered by brokerage
    firms and commercial banks are traded in
    the over-the-counter market.

    Efficiency of
    Currency Futures and Options
    If foreign exchange markets are
    efficient, speculation in the currency
    futures and options markets should not
    consistently generate abnormally large
    profits.

    European Currency
    Options
    European-style currency options are
    similar to American-style options except
    that they can only be exercised on the
    expiration date.
    For firms that purchase options to hedge
    future cash flows, this loss in flexibility is
    probably not an issue. Hence, if their
    premiums are lower, European-style
    currency options may be preferred.

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