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7/31/2019 Currency Futures and Options_Final
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Introduction
Forwards, futures, and options arecollectively known as derivatives
What is a derivative?
Why are derivatives useful?They help eliminate the price risk inherent in
transactions that call for future delivery ofmoney, security, or a commodity.
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Currency Futures &
Options Markets
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Objectives: to Understand
The nature of currency futures and optionscontracts and how they are used to managecurrency risk & to speculate on futurecurrency movements
The difference between forward & futurescontracts
The difference between futures & optionscontracts
The factors that determine the value of anoption
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Currency Futures
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Currency futures
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What is currency futures
A transferable futures contract that specifies
the price at which a specified currency can
be bought or sold at a future date. Currencyfuture contracts allow investors to hedge
against foreign exchange risk.
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History
of Currency futures Currency futures were first created at the
Chicago Mercantile Exchange (CME) in
1972 International Monetary Market(IMM)
launched trading in seven currency futures
on May 16, 1972.
http://www.answers.com/topic/chicago-mercantile-exchangehttp://www.answers.com/topic/1972http://en.wikipedia.org/wiki/International_Monetary_Markethttp://en.wikipedia.org/wiki/May_16http://en.wikipedia.org/wiki/1972http://en.wikipedia.org/wiki/1972http://en.wikipedia.org/wiki/May_16http://en.wikipedia.org/wiki/International_Monetary_Markethttp://www.answers.com/topic/1972http://www.answers.com/topic/chicago-mercantile-exchange7/31/2019 Currency Futures and Options_Final
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Currency futures in India
Currency futures trading was started in Mumbai August29, 2008.
With over 300 trading members including 11 banks
registered in this segment, the first day saw a very livelycounter, with nearly 70,000 contracts being traded.
The first trade on the NSE was by East India Securities Ltd
Amongst the banks, HDFC Bank carried out the first trade.The largest trade was by Standard Chartered Bank
constituting 15,000 contracts. Banks contributed 40percent of the total gross volume.
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Fundamentals of Indian currency
futures Currency futures can be traded between Indian
rupees and US dollar (US$ -- INR)
The trading of Indian currency futures can bedone between 9 am to 5 pm
The minimum size of currency futures is US$1000 periodically the value of the contract can
be changed by RBI and SEBI The currency future can have maximum validity
of 12 months
The currency futures contract can be settled in
cash
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Trade exchanges for currency
futures There are 3 trade exchange that trades in
currency futures
1. National Stock Exchange (NSE)
2. Bombay Stock Exchange (BSE)
3. Multi-Commodity Exchange (MCX)
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Futures Contracts
A futures contract is an agreement to buy or sell a
specified quantity of a specified asset at a certain
point in the future at a price agreed upon today In the case of currencies, it is an agreement to
buy/sell a specified quantity of a specific currency
at a pre agreed upon exchange rate at a certain
time in the future
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Meaning
It is a derivative instrument
Definition is the same as currency forward
Forwards are traded over the counter Futures are traded in organised exchanges
(separate financial futures exchanges)
Futures are transacted through brokers Traded only in a limited number of currencies
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Features
Standardised terms
Clearing house
Margin system
Closing of futures
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Standardised terms
Contract size is standardised
Example: 62,500 Sterling; 125,000 Euro;
100,000 Can DollarChicago Mercantileexchange
Date of delivery is predetermined
Third Wednesday of Jan, March, April,
June, July, Sept., Oct., Dec.
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Clearing house
Each exchange has a clearing house
Clearing house arranges for delivery of asset and
payment of money Clearing house becomes the counter party to theoriginal parties Original parties: buyer and seller
Clearing house becomes counter party to buyer (todeliver the asset)
Clearing house becomes the counter party to the seller(to make payment)
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A. Margin
Sometimes called the deposit, the
margin represents security to cover any
loss in the market value of the contractthat may result from adverse price
changes. This is the cost of trading in
the futures market.
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Margin system
There are 3 types of margins
Initial margin, maintenance margin and variation
margin Initial margin to be paid upfront
Balance is marked to the market every day
Maintenance margin to be maintained throughout
the duration of the contract Variation margin (shortfall in margin) to be
remitted promptly
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Example for margin system
Can Dollar futures: size = 100,000 Can D
Dealer buys one contract at USD 0.75/ Can D
Value of contract: USD 75,000 Initial margin: 10 percent = USD 7,500
Maintenance margin: 7.5 percent = USD 5,625
Price moves upto USD 0.755/ Can D: dealer gains
USD 500 (100,000 * USD 0.005) Price moves down to USD 0.740: dealer loses
USD 1000 (100,000*USD 0.010)
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FUTURES CONTRACTS
Available Futures Currencies:
1.) British pound 5.) Euro
2.) Canadian dollar 6.) Japanese yen
3.) Deutsche mark 7.) Australian dollar
4.) Swiss franc
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Currency Futures Market
The contracts can be traded by firms or
individuals through brokers on the trading
floor of an exchange (e.g. ChicagoMercantile Exchange), automated trading
systems (e.g. GLOBEX), or the over-the-
counter market.
Brokers who fulfill orders to buy or sell
futures contracts typically charge a
commission.
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FUTURES CONTRACTS
B. Forward vs. Futures Contracts
Basic differences:
1. Trading Locations 6. SettlementDate
2. Regulation 7. Quotes
3. Frequency of 8. Transactiondelivery costs
4. Size of contract 9. Margins
5. Delivery dates 10. Credit risk
F t d F d A
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Futures and Forwards: A
Comparison Table
Default Risk: Borne by Clearinghouse Borne by Counter-Parties
What to Trade: Standardized Negotiable
The Forward/Futures Agreed on at Time Agreed on at Time
Price of Trade Then, of Trade. Payment at
Marked-to-Market Contract Termination
Where to Trade: Standardized Negotiable
When to Trade: Standardized Negotiable
Liquidity Risk: Clearinghouse Makes it Cannot Exit as Easily:
Easy to Exit Commitment Must Make an Entire
New Contrtact
How Much to Trade: Standardized Negotiable
What Type to Trade: Standardized Negotiable
Margin Required Collateral is negotiable
Typical Holding Pd. Offset prior to delivery Delivery takes place
Futures Forwards
Comparison of the Forward & Futures
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Delivery date Customized Standardized
Participants Banks, brokers, Banks, brokers,MNCs. Public MNCs. Qualifiedspeculation not public speculation
encouraged. encouraged.
Security Compensating Small securitydeposit bank balances or deposit required.
credit lines needed.
Clearing Handled by Handled byoperation individual banks exchange
& brokers. clearinghouse.Daily settlementsto market prices.
Comparison of the Forward & FuturesMarketsForward Markets Futures Markets
Contract size Customized Standardized
Comparison of the Forward & Futures
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Regulation Self-regulating Commodity
Futures TradingCommission,
National FuturesAssociation.
Liquidation Mostly settled by Mostly settled byactual delivery. offset.
Transaction Banks bid/ask NegotiatedCosts spread. brokerage fees.
Comparison of the Forward & FuturesMarkets
Forward Markets Futures Markets
Marketplace Worldwide Central exchangetelephone floor with worldwidenetwork communications.
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Enforced by potential arbitrage activities,
the prices of currency futures are closely
related to their corresponding forward ratesand spot rates.
Currency futures contracts are guaranteed
by the exchange clearinghouse, which inturn minimizes its own credit risk by
imposing margin requirements on those
market participants who take a position.
Currency Futures Market
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Speculators often sell currency futures
when they expect the underlying
currency to depreciate, and vice versa.
Currency Futures Market
1. Contract to sell 500,000pesos @ $.09/peso($45,000) on June 17.
April 4
2. Buy 500,000 pesos @ $.08/peso($40,000) from the spot market.
June 17
3. Sell the pesos to fulfill contract.Gain $5,000.
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MNCs may purchase currency futures to
hedge their foreign currency payables, or
sell currency futures to hedge their
receivables.
Currency Futures Market
1. Expect to receive 500,000pesos. Contract to sell 500,000pesos @ $.09/peso on June17.
April 4
2. Receive 500,000 pesos asexpected.
June 17
3. Sell the pesos at the locked-inrate.
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Holders of futures contracts can close out
their positions by selling similar futures
contracts. Sellers may also close out theirpositions by purchasing similar contracts.
Currency Futures Market
1. Contract to buy
A$100,000 @$.53/A$ ($53,000) onMarch 19.
January 10
3. Incurs $3000 loss from
offsetting positions infutures contracts.
March 19
2. Contract to sell
A$100,000 @$.50/A$ ($50,000) onMarch 19.
February 15
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FUTURES CONTRACTS
Maximum price movementsContracts set to a daily price limit restricting maximum
daily price movements.
If limit is reached, a margin call may be necessary to
maintain a minimum margin
Transaction costs:
payment of commission to a trader Leverage is high
Initial margin required is relatively low (e.g. less than.02% of sterling contract value).
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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.
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A. Forward vs. Futures Markets
(continued) Assume initial margin was $1400 and
maintenance margin is $1100. A has already
sustained a loss of $150 so the value of the
margin account is $1250. If the price drops the
following day another $200 loss is registered.
The value of the margin account is down to
$1050, below the maintenance margin. This
means A will be required to bring the margin
account back to $1400.
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B. Speculating
Assume a speculator buys a JUNE contract
at $459.40 by depositing the required
margin of $3,500. One gold contract = 100 troy ounces, it has
a market value of $45,940.
Hence margin is: $3,500/45,940 = 7.62%
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B. Speculating (continued)
1. If Gold contract goes up to $500/ounce
by May, then:
Profit = $500 - $459.40 = $40.60*100Return = $4060/$3500 = 116%
2. If Gold contract goes down to
$410.00/ounce by May, then:Profit = $410 - $459.40 = - 49.40*100
- 4940/3500 = -1.41 or
Return = 141%
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B. Speculating (continued)
3. Assume the speculator shorts by
selling the JUNE contract. If price
decreases then:Receives: (459.40 - 410) = 49.40*100
Profit: $4940
Return: 4940/3500 = +141%
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FUTURES CONTRACTS
Advantages of futures:
1.) Smaller
contract size2.) Easy liquidation
3.) Well- organized
and stablemarket.
Disadvantages of futures:
1.) Limited to 7
currencies2.) Limited dates
of delivery
3.) Rigid contractsizes.
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B. Purposes of Futures Markets
Meets the needs of three groups of futures
market users:
1. Those who wish to discover informationabout future prices of commodities (suppliers)
2. Those who wish to speculate (speculators)
3. Those who wish to transfer risk to some
other party (hedgers)
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Currency Futures
Performance Bond or Initial Margin: Thecustomer must put up funds to guarantee thefulfillment of the contract - cash, letter of
credit, Treasuries. Maintenance Performance Bond or Margin:
The minimum amount the performance bondcan fall to before being fully replenished.
Mark-to-the-market: A daily settlementprocedure that marks profits or lossesincurred on the futures to the customersmargin account.
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Sample Performance BondRequirements
From the CME, 15 March 2000
Currency Futures Initial MaintenanceAustralian Dollar $1,317 $975British Pound $1,620 $1,200Canadian Dollar $642 $475Deutsche Mark $1,249 $925Euro $2,430 $1,800
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Long and Short Exposures
A person that is, for example, long the pound,has pound denominated assets that exceed
in value their pound denominated liabilities. A person that is short the pound, has pound
denominated liabilities that exceed in valuetheir pound denominated assets.
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Hedging With a Currency
Future To hedge a foreign exchange exposure, thecustomer assumes a position in the oppositedirection of the exposure.
For example, if the customer is long thepound, they would short the futures market.
A customer that is long in the futures marketis betting on an increase in the value of thecurrency, whereas with a short position theyare betting on a decrease in the value of thecurrency.
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How an Order is Executed (Figure from the CME)
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Corporate Use of Currency
Futures Hedge open positions in foreign currencies by
buying/selling currency futures
Foreign currency cash inflows Risk: domestic currency may appreciate
Strategy: sell foreign currency in the futures market at
the futures exchange rate (Short)
Foreign currency cash outflows Risk: domestic currency may depreciate
Strategy: buy foreign currency in the futures market at
the futures exchange rate (Long)
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A. Reading Futures Prices
(Contracts)1. The Product
2. The Exchange
3. Size of the Contract
4. Method of Valuing Contract
5. The delivery month
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A. Reading Futures Prices
(Prices)1. Opening
2. High
3. Low
4. Settlement
Price at which the contracts are settled at the
close of trading for the day Typically the last trading price for the day
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B. The Basis
...is the current cash price of a particular
commodity minus the price of a futures
contract for the same commodity. BASIS = CURRENT CASH PRICEFP
FPfuture price
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B. The Basis (continued)
Example: Gold Prices and the Basis:
12/16/03
BasisCash $441.00
DEC 441.50 -.50
MAR 04 449.20 - $7.70
JUN 459.40 -$17.90SEP 469.90 -$28.40
DEC 480.70 -$39.20
MAR 05 491.80 -$50.30
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B. The Basis (continued)
1. Relation between Cash & Futures
2. Spreads
The difference between two futures
prices (same type of contract) at two
different points in time
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C. Spreading
Combining two or more different
contracts into one investment
position that offers the potential for
generating a modest profit
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C. Spreading (continued)
Ex: Buy 1 Corn contract at 258
Sell (short) 1 Corn contract at 270
Close out by: 1. Selling the long contract at 264
2. Buy a short contract at 273
Profit: Long: 264-258 = 6
Short: 270-273 = -3
Profit: = 6 -3 = 3
3 * 5000 bu. = $150 Net
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Currency Options
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CURRENCY OPTIONS
Definition:
a contract from a writer ( the seller) that
gives the right not the obligation to theholder (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
Types of Currency Options:
a. American
exercise date may occur anytime up to the expiration date.
b. European
exercise date occurs only at theexpiration date.
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CURRENCY OPTIONS
Exercise Price
a. Sometimes known as the
strike price.
b. the exchange rate at which theoption holder can buy or sellthe contracted currency.
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CURRENCY OPTIONS
Status of an option
a. In-the-money
Call: Spot > strikePut: Spot < strike
b. Out-of-the-moneyCall: Spot < strike
Put: Spot > strike
c. At-the-moneySpot = the strike
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CURRENCY OPTIONS
The premium: the price of an
option that the writer charges thebuyer.
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CURRENCY OPTIONSWhen to Use Currency Options
1. For the firm hedging foreignexchange risk
a. With sizable unrealized gains.b. With foreign currency flows
forthcoming.
2. For speculators- profit from favorable exchange rate
changes.
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CURRENCY OPTIONS
Option Pricing and Valuation
1. Value of an option equals
a. Intrinsic valueb. Time value
2. Intrinsic Value
- the amount in-the-money3. Time Value - the amount the option is
in excess of its intrinsic value.
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CURRENCY OPTIONS
2. Intrinsic Value
the amount in-the-money
3. Time Value
the amount the option is in
excess of its intrinsic value.
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CURRENCY OPTIONS
4. Other factors affecting the value of an option
a. value rises with longertime to expiration.
b. value rises when greater volatility in theexchange rate.
5. Value is complicated by both the home and foreign
interest
rates.
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CURRENCY OPTIONS
E. Market Structure
1. Location
a. Organized Exchanges
b. Over-the-counter
1.) Two levelsretail and wholesale
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Currency Options
A currency option is a contract that givesthe owner the right, but not the obligation, tobuy or sell a currency at a specified price at
or during a given time. Call Option: An option that gives the owner
the right to buy a currency.
Put Option: An option that gives the ownerthe right to sell a currency.
How are currency options simultaneouslyboth put & call options?
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Currency Options
American Option: An option that canbe exercised any time before or on theexpiration date.
European Option: An option that canonly be exercised on the expirationdate.
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Currency Options
Exercise orStrike Price: The price (spotexchange rate) at which the option may beexercised.
Option Premium: The amount that must bepaid to purchase the option contract.
Break-Even: The point at which exercising
the option exactly matches the premium paid.
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Currency Options
If the spot rate has not yet reached theexercise price [SX], the option is said to be in themoney.
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Call Option
The holder of a call option expects theunderlying currency to appreciate in value.
Consider 4 call options on the euro, with astrike price of 92 ($/) and a premium of 0.94(both cents per).
The face amount of a euro option is 62,500.
The total premium is:
$0.0094462,500=$2,350.
C ll O ti H th ti l P Off
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Profit
Loss
88.15
92 92.94
93.5
Payoff Profile
Spot Rate
-$2,350
-$1,100
0
$1,400
Out-of-
the-money At In-the-money
Call Option: Hypothetical Pay-Off
92.5
Break-Even
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Put Option
The holder of a put option expects theunderlying currency to depreciate in value.
Consider 8 put options on the euro with astrike of 90 ($/) and a premium of 1.95 (bothcents per).
The face amount of a euro option is 62,500.
The total premium is:
$0.0195862,500=$9,750.
Put Option: Hypothetical payoff
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Profit
Loss
88.05 90
Payoff Profile
Spot Rate
-$9,750
-$5000
In-the-money At Out-of-the-money
Put Option: Hypothetical payoff
at a spot rate of 88.15
88.15
Break-Even
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Option Pricing & Valuation
Value of a call option at maturity S-X, where S-X>0 [otherwise value is
zero], = Intrinsic value
Value of a call option prior to maturity Intrinsic value + Time value
Time Value is a function of:
Time to expiration, volatility, domestic &foreign interest rate differentials
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Comparing Futures and OptionsThe value of a futures contract at maturity (date t+n) to purchase one
unit of foreign currency will be:
Value
0 St+n
The value of the futures contractis zero at maturity if the spot rateat maturity is equal to the current
futures rate.
Zt,t+n
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But were missing something. While a futures contract has an
expected return of zero, the value of the option looks like it is
always positive
Value
0 St+nX
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Hence, anyone taking the opposite side of the transaction
(writing the option) will demand a price (C) that makes the
expected value zero once again:
Value
0 St+n
Regardless of the outcome,the options value is reduced
everywhere by the certainpayment of its price.
XC
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The value of an option to sell one unit of foreign currency (a
put option) at a strike price equal to a corresponding futures
contract price will have similar properties:
Value
0 St+nX
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Foreign Currency Swaps
A currency swap is an exchange of debt-service
obligations denominated in one currency for the
service on an agreed upon principal amount of debt
denominated in another currency.A currency swap is often the low-cost way of
obtaining a liability in a currency in which a firm has
difficulty borrowing.
A pair of firms simply borrow in currencies they have
relative advantage borrowing in, and then trade the
obligations of their respective loans, thereby
effectively borrowing in their desired currency.
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Dell
SFr
Dell computers would like to borrow in Swiss Francsto hedge its ongoing cash flows from that country
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Dell Nestle
SFr$
Nestle would like to borrow in Dollars to hedge itssales to the U.S...
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Dell Nestle
SFr$
But both firms are relatively unknown to the respectivecredit markets, and thus anticipate unfavorableborrowing terms.
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Dell Nestle
I-Bank SFr$
But an investment bank comes along and suggeststhat each borrow in the credit markets that arecomfortable with them...
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Dell Nestle
SFr$
and then the investment bank will give them
sufficient cash flows each period to cover theobligations of these loans...
$ Sfr
I-Bank
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Dell Nestle
SFr$
in return for making the payments in the foreign
currency that exactly match the other firms
obligations.
$ Sfr
Sfr $
I-Bank
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I-Bank
Dell Nestle
SFr$
In other words, the swap effectively completes themarket. Giving each firm access to the foreign debtmarket at reasonable terms.
$ Sfr
Sfr $
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The All-In Cost of a Swap
Clearly, the relative magnitudes of the respectivepayments determine each firms ultimate cost of
borrowing.
This cost is called the all-in cost. It is the effectiveinterest rate the firm ends up paying on the moneythat it raised.
It is the discount rate that equates the NPV of future
interest and principal payments to the net proceedsreceived by the issuer.
IRR
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Swaps vs. Forwards
Notice that on a one-year loan, a currency swap isno different than a one-year forward contract.
In fact, a currency swap can really be thought of as
a firm taking a domestic currency loan andpurchasing a series of forward contracts to convertthe payments into known foreign currencyobligations.
The implied forward rates need not equal the actualforward rates, but taken as a whole, shouldresemble an average forward rate over the term ofthe loan.
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Key Points
4. Futures contracts, traded on highly liquid exchanges, havethe benefit that they can be sold on the market before thematurity date. As a result, futures contracts are particularlyuseful for hedging exposures whose maturity is uncertain.
5. On the other hand, futures contracts are standardized interms of timing and quantities, and therefore they rarely offer aperfect hedge.
6. Options contracts allow a firm to hedge against movementsin one direction while retaining exposure in the other.
7. Options are particularly useful in hedging exposures that arehighly uncertain with respect to timing and magnitude.
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Key Points
8. Currency swaps offer firms the ability to borrow againstlong-term foreign currency exposures when access to foreigndebt markets is costly.
9. Currency swaps converts a domestic liability into a
foreign one via what are effectively a bundle of long-datedforward contracts between two firms.
10. The effective cost of a currency swap is its all-in cost -the effective rate of interest that the firm ends up paying onthe constructed foreign liability.
11. Currency swaps require only that firms have differentialrelative - rather than absolute - advantage in accessing debtmarkets.
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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 inthe over-the-counter market.
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A currency call option grants the holder the right to buy a
specific currency at a specific price (called the exercise or
strike price) within a specific period of time.
A call option is
in the money if exchange rate > strike price,
at the money if exchange rate = strike price,
out of the money
if exchange rate < strike price.
Currency Call Options
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Option owners can sell or exercise their
options, or let their options expire.
Call option premiums will be higher when:
(spot pricestrike price) is larger;
the time to expiration date is longer; and
the variability of the currency is greater.
Firms may purchase currency call options
to hedge payables, project bidding, or target
bidding.
Currency Call Options
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Speculators may purchase call options on a
currency that they expect to appreciate.
Profit = selling(spot)priceoptionpremium
buying(strike)price
At breakeven, profit = 0.
They may also sell (write) call options on a
currency that they expect to depreciate.
Profit = optionpremiumbuying(spot)price +
selling(strike)price
Currency Call Options
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A currency put option grants the holder the right to sell a
specific currency at a specific price (the strike price) within
a specific period of time.
A put option is
in the money if exchange rate < strike price,
at the money if exchange rate = strike price,
out of the money
if exchange rate > strike price.
Currency Put Options
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Put option premiums will be higher when:
(strike pricespot rate) is larger;
the time to expiration date is longer; and
the variability of the currency is greater.
Firms may purchase currency put options to
hedge future receivables.
Currency Put Options
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One possible speculative strategy for
volatile currencies is to purchase both a put
option and a call option at the same exercise
price. This is called a straddle.
By purchasing both options, the speculator
may gain if the currency moves
substantially in either direction, or if it
moves in one direction followed by the
other.
Currency Put Options
Efficiency of
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Efficiency ofCurrency Futures and Options
If foreign exchange markets are efficient,
speculation in the currency futures and
options markets should not consistently
generate abnormally large profits.
http://www.ino.com/Currency quotes
Contingency Graphs for Currency Options
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Contingency Graphs for Currency Options
+$.02
+$.04
$.02
$.04
0
$1.46 $1.50 $1.54
Net Profitper Unit
FutureSpotRate
For Buyer of Call Option
Strike price = $1.50Premium = $ .02
+$.02
+$.04
$.02
$.04
0
$1.46 $1.50 $1.54
Net Profitper Unit
FutureSpotRate
For Seller of Call Option
Strike price = $1.50Premium = $ .02
Contingency Graphs for Currency Options
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Contingency Graphs for Currency Options
+$.02
+$.04
$.02
$.04
0
$1.46 $1.50 $1.54
Net Profitper Unit
FutureSpotRate
For Seller of Put Option
Strike price = $1.50Premium = $ .03
+$.02
+$.04
$.02
$.04
0
$1.46 $1.50 $1.54
NetProfit per
Unit
Future SpotRate
For Buyer of Put Option
Strike price = $1.50Premium = $ .03
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Closing of futures
Forward contract is settled on delivery date by
delivery of asset and payment of money
Futures can be closed:
Exchange of asset and cash on delivery date
Cash settlement through a reverse trade on any day
Hedgers prefer exchange of asset; speculators
prefer cash settlement
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Hedging with currency futures
Importer buys the required currency futurescontract
Thus locks in a price for the purchase of foreign
currency Hedges (avoids) risk due to exchange rate
fluctuations
Exporter sells the expected currency futurescontract
locks in a price for the sale
Hedges risk due to exchange rate fluctuations
Imperfections in hedging with
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currency futures
Maturity mismatch
Mismatch in maturity date of futures contract and date
of cash transaction
Size mismatch
Mismatch between size of futures contract and size of
cash transaction
Maturity and size mismatch Hedging with currency futures may not result in
perfect hedge
Speculation with currency futuresFl i i h d
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Fluctuations in exchange rates used to reapspeculative profits
Spot rate: USD = Rs.46.40 1 month future rate: USD = Rs.46.60
Expected spot rate on maturity: USD = Rs. 46.75
Dealer buys one currency futures contract of size100,000 USD
Value of contract: Rs.46,60,000; Margin deposit:Rs.4,66,000
If exchange rate move up to Rs.46.75 asanticipated, dealer gains profit of Rs.15,000(100,000* Re.0.15)
Rate of return: (15000/466,000)(12)(100) =
38.63%
Speculation through cash
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Speculation through cash
transaction Spot rate: USD = Rs.46.40 Dealer buys 100,000 USD at spot rate
Investment required: Rs.46,40,000
If exchange rate moves upto Rs.46.75 within amonth, dealer gains profit of Rs.35,000 (100,000*Re.0.35)
Rate of return: (35000/46,40,000)(12)(100) =9.05%
Speculation with currency futures - larger