CHAPTER 8 Currency Futures and Options Markets. PART I Futures Contracts.
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Transcript of CHAPTER 8 Currency Futures and Options Markets. PART I Futures Contracts.
CHAPTER 8
Currency Futures and Options Markets
PART I
Futures Contracts
FUTURES CONTRACTS
I. CURRENCY FUTURESA. Market History:
1. Backgrounda. Long historyb. Extremely volatile due to theirinformation driven naturec. The market plays a Price Discovery
Role for other financial markets such as the cash markets
FUTURES CONTRACTS
B. International Monetary Market (IMM) 1972: opened by the Chicago Mercantile Exchange
Purpose:
to provide a stable market for the exchange of currency futures.
FUTURES CONTRACTS
2. IMM providesa. an outlet for hedging currency
risk with futures contracts.
Definition of a Futures Contract:
contracts written requiring a standard quantity of an available currency at a fixed exchange rate at a set delivery date.
FUTURES CONTRACTS
b. Available Futures Contracts Currency/ Contract Size:
1.) British pound / 62,5002.) Canadian dollar /100,0003.) Euro / 125,0004.) Swiss franc / 125,0005.) Japanese yen / 12.5 million6.) Mexican peso / 500,0007.) Australian dollar / 100,000
FUTURES CONTRACTS
c. Transaction costs:in the form of a commission payment to
a floor trader
d. Leverage is high1.) Initial margin required is
relatively low (less than 2% of
contract value).
FUTURES CONTRACTS: SAFEGUARDS
e. Maximum price movement rules:
Contracts set daily to a price
limit that restricts maximum
daily upward and downward
movements.
FUTURES CONTRACTS: SAFEGUARDS
f. Maintenance Margins:
When the account balance falls below
the maintenance margin, a margin
call may be necessary to maintain the
minimum balance.
FUTURES CONTRACTS
g. Global futures exchanges:1.) I.M.M. International Monetary
Market2.) L.I.F.F.E.London International
Financial Futures Exchange3.) C.B.O.T. Chicago Board of Trade4.) S.I.M.E.X.Singapore International
Monetary Exchange5.) D.T.B. Deutsche Termin Bourse6.) H.K.F.E. Hong Kong Futures
Exchange
FUTURES CONTRACTS
B. Forward vs. Futures ContractsBasic differences:1. Trading Locations 6. Quotes2. Regulation 7. Margins3. Frequency of 8. Credit risk delivery 4. Size of contract 5. Transaction Costs
FUTURES CONTRACTS
Advantages of futures:
1.) Easy liquidation
2.) Well- organized and stable
market.
Disadvantages of futures:
1.) Limited to 7
currencies
2.) Limited dates
of delivery
3.) Rigid contract
sizes.
PART II
Currency Options
CURRENCY OPTIONS
I. OPTIONSA. Currency options
1. offer another method to hedge exchange rate risk.
2. first offered on PhiladelphiaExchange (PHLX).
3. HOW CURRENCY OPTIONS ARE PURCHASED
Buyers Sellers=Writers
Buy Sell Buy Sell
CALL
PUT
Premium
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. Expiration Dates of Currency Options:
a. American
exercise date may occur anytime up to the expiration date.
b. European
exercise date occurs only at theexpiration date and not before.
6. What is the premium?
the price of an option that the writer charges the buyer.
CURRENCY OPTIONS
7.Exercise Pricea. Sometimes known as the
strike price.
b. The exchange rate at which the option holder can buy or sell the contracted currency.
CURRENCY OPTIONS
c. Types of Currency Options:
1.) Calls – give the owner the right to buy the currency
2.) Puts – give the owner the right to sell the currency
CURRENCY OPTIONS
8. Status of an optiona. In-the-money
Call: Spot > strikePut: Spot < strike
b. Out-of-the-moneyCall: Spot < strikePut: Spot > strike
c. At-the-moneySpot = the strike
CURRENCY OPTIONS
9. Why Use Currency Options?1. For the firm hedging foreign
exchange risk when a future event is very uncertain.
2. For speculators
who profit from favorable exchange rate changes.