1 / 11

International Finance FINA 5331 Lecture 9: Forward contracts Interest rate parity

International Finance FINA 5331 Lecture 9: Forward contracts Interest rate parity Read: Chapter 5 (125-129) Chapter 6 (125-129) Aaron Smallwood Ph.D. In class exercise. 小木头的银行 Quotes:

caldwell-dunlap
Download Presentation

International Finance FINA 5331 Lecture 9: Forward contracts Interest rate parity

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. International Finance FINA 5331 Lecture 9: Forward contracts Interest rate parity Read: Chapter 5 (125-129) Chapter 6 (125-129) Aaron Smallwood Ph.D.

  2. In class exercise • 小木头的银行 • Quotes: • For your group, please refer to the handout that was given for individual quotes and individual currencies.

  3. Review: Terminology • Long vs short: • A trader is long in a currency when they are owed that currency in the future. A trader is short in a currency when they owe that currency in the future. • Hedging • The act of reversing a natural short or long position, such that no net position is taken. • Speculation • The act of intentionally creating a short or long position in an attempt to profit on currency movements. This exposes the trader to risk. • Arbitrage • The act of simultaneously buying and selling an asset, such that no net position remains.

  4. Forward contracts • Forward contracts: Allow traders to buy/sell foreign currency for delivery in the future, for a price that is known TODAY. • We considered both outright forward contracts and non-deliverable forward contracts (NDFs). • Example: Suppose the 3 month forward contract for Swiss Franc: $1.1280. 3 months from today, we could buy or sell SF at this price.

  5. Forward contracts • Let’s review aspects of deliverable forward contracts: • 1. A forward contract is a derivative asset, based off of a spot contract. The forward market is known as an “over the counter” (OTC) market, as compared to futures markets, where trade typically occurs on a centralized exchange. • 2. The terms of a forward contract are negotiated between a bank/dealer and their client. At least in theory, except where capital controls may be present, a forward contract can be written for any currency. • 3. Based on 2, a forward contract can be written for delivery at any point in the future. • 4. Again, based on 2, a forward contract can be written in any “lot size.”

  6. Forward rates • When the forward rate exceeds the spot rate, the foreign currency (currency in the denominator) is trading at a “forward premium.” • Example: If, S($/SF)= $1.1271…F($/SF)3m=$1.1280, SF is selling at premium. • …When the forward rate is less than the spot, the foreign currency is said to be selling at a “forward discount.” • Example: If, S($/£)=$1.6725… …F($/£)3m=1.6714, the pound is selling at a discount.

  7. Forward rates • Like spot rates, banks will buy forward foreign currency at one price (the bid price) and sell it forward at another price (the ask price). • When the spot quotation is provided, the dealer will simply quote basis points for the associated forward rates. • For the basis points, the trader will understand that if the first quote exceeds the second, the basis points are subtracted from the spot quotations. • If the first number in the quote is less than the second, the basis points are added. • A basis point is defined as 0.0001.

  8. Example • Suppose we call our dealer and ask for forward quotes relative to the spot rate for Canadian $. Our dealer supplies the following information: • Spot: $1.0480-86 • 1 month forward “12-10” • 3 month forward “14-8” • 6 month forward “16-2” • One month forward rates: $1.0468-$1.0476 • Three month forward rates: $1.0466 - $1.0478 • Six month forward rates: $1.0464 - $1.0484.

  9. Forward premia/discount • In some sense, the premium or discount provides information related to how the value of a currency changes over time. We can express these values in percentage terms. We will typically apply annualization. The calculation: • Where “days” is the number of days until the contract matures.

  10. Example • Suppose the three month forward rate on yen today is $0.009779. The current spot rate $0.009774. Suppose a contract written for yen matures 92 days from now. The yen is trading at a premium: • The yen is selling at 0.200% premium.

  11. Premia/Discount Cont. • If F>S, in some sense, this might signal that we expect foreign currency to appreciate in value. • If F<S, this might indicate that we expect the foreign currency to depreciate in value.

More Related