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.
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CHAPTER 8
Currency Futures and Options Markets
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PART I
Futures Contracts
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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
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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.
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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.
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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
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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).
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FUTURES CONTRACTS: SAFEGUARDS
e. Maximum price movement rules:
Contracts set daily to a price
limit that restricts maximum
daily upward and downward
movements.
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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.
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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
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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
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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.
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PART II
Currency Options
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CURRENCY OPTIONS
I. OPTIONSA. Currency options
1. offer another method to hedge exchange rate risk.
2. first offered on PhiladelphiaExchange (PHLX).
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3. HOW CURRENCY OPTIONS ARE PURCHASED
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 anytime up to the expiration date.
b. European
exercise date occurs only at theexpiration date and not before.
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6. What is the premium?
the price of an option that the writer charges the buyer.
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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.
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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
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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. 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.