Foundations of Multinational Financial Management5th EditionAlan Shapiro J.Wiley & Sons

Power Points by

Joseph F. Greco, Ph.D.

California State University, Fullerton

Currency Futures and Options Markets

Chapter 8

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PART I.FUTURES CONTRACTS

I. CURRENCY FUTURESA. Background

1. Long history2. Extremely volatile due to

information driven nature3. Price Discovery Role

Financial derivatives: they are contracts that derive their value from some underlying asset(stock , bond, currency)

1.Forwards 2.Futures 3.Options 4.SWAP

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FUTURES CONTRACTS

1972: Chicago Mercantile Exchange(CME芝加哥商品交易所 ) opens the International Monetary Market (IMM).

Purpose: speculator vs hedger

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FUTURES CONTRACTS

2. IMM provides

a. an outlet for hedging currency

risk with futures contracts.

Definition:

contracts written requiring a standard quantity of an

available currency at a fixed exchange rate at a set delivery date.

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FUTURES CONTRACTS

b. Available Futures Currencies/Contract Size:

1.) British pound / 62,500

2.) Canadian dollar /100,000

3.) Euro / 125,000

4.) Swiss franc / 125,000

5.) Japanese yen / 12.5 million

6.) Mexican peso / 500,000

7.) Australian dollar / 100,000

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FUTURES CONTRACTS

c. Transaction costs:

commission payment to a floor trader

d. Leverage is high1.) Initial margin required is

relatively low (less than 2% of contract value).

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FUTURES CONTRACTS: SAFEGUARDS

e. Maximum price movements1.) Contracts set to a daily price

limit restricting maximum daily price movements.

2.) If limit is reached, a margin call may be necessary to

maintain a minimum margin保證金 .

Initial Margin:當期貨交易開始時需具備的金額 Maintenance Margin:當低於維持保證金時，必須補足金額至原始保證金的額度

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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

平倉 (offsetting trade):一買一賣抵銷交易，不用到期交割

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FUTURES CONTRACTS

B. Forward vs. Futures ContractsBasic differences:1. Trading Locations 6. Quotes

2. Regulation 7. Margins3. Frequency of 8. Credit risk delivery 4. Size of contract 5. Transaction Costs

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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.

CURRENCY OPTIONS

PART II

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CURRENCY OPTIONS

I. OPTIONS

A. Currency options 1. Offer another method to

hedge exchange rate risk.

2. First offered on PhiladelphiaExchange (PHLX).

3. Fastest growing segment ofthe hedge markets.

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CURRENCY OPTIONS

Buyers Sellers=Writers

Buy Sell Buy Sell

CALL

PUT

Premium

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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.

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CURRENCY OPTIONS

5. Expiration Dates 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 and not before.

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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.

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CURRENCY OPTIONS

c. Types of Currency Options:

1.) Calls

2.) Puts

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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

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CURRENCY OPTIONS

9. What is the premium?

- The price of an option that the writer charges the buyer.

B. Why Use Currency Options?

1. For the firm hedging foreign exchange risk with Future event is very uncertain gains.

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CURRENCY OPTIONS

2. For speculators

- profit from favorable exchange rate changes.

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CURRENCY OPTIONS

C. Using Forward or Futures Contracts

Forward or futures contracts aremore suitable for hedging a

known amount of foreign currency flow.

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Options Sample Problems

Ford buys a French put option (contract size: FF250,000) at a premium of $.01/FF. If the exercise price is $.21 and the spot at expiration is $.216, what is Ford’s profit (loss)?