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CHAPTER 8

CHAPTER 8. Currency Futures and Options Markets. PART I. Futures Contracts. FUTURES CONTRACTS. I . CURRENCY FUTURES A. Market History: 1. Background a. Long history b. Extremely volatile due to their information driven nature

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CHAPTER 8

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  1. CHAPTER 8 Currency Futures and Options Markets

  2. PART I Futures Contracts

  3. FUTURES CONTRACTS • I. CURRENCY FUTURES • A. Market History: • 1. Background • a. Long history • b. Extremely volatile due to their information driven nature • c. The market plays a Price Discovery Role for other financial markets such as the cash markets

  4. 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.

  5. FUTURES CONTRACTS • 2. IMM provides • a. 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.

  6. FUTURES CONTRACTS • b. Available Futures Contracts • Currency/ 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

  7. FUTURES CONTRACTS • c. Transaction costs: • in the form of a commission payment to a floor trader • d. Leverage is high • 1.) Initial margin required is • relatively low (less than 2% of • contract value).

  8. FUTURES CONTRACTS: SAFEGUARDS • e. Maximum price movement rules: • Contracts set daily to a price • limit that restricts maximum • daily upward and downward movements.

  9. 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.

  10. FUTURES CONTRACTS • g. Global futures exchanges: • 1.) I.M.M. International Monetary Market • 2.) L.I.F.F.E.London International Financial Futures Exchange • 3.) C.B.O.T. Chicago Board of Trade • 4.) S.I.M.E.X.Singapore International • Monetary Exchange • 5.) D.T.B. Deutsche Termin Bourse • 6.) H.K.F.E. Hong Kong Futures Exchange

  11. FUTURES CONTRACTS • B. Forward vs. Futures Contracts • Basic differences: • 1. Trading Locations 6. Quotes • 2. Regulation 7. Margins • 3. Frequency of 8. Credit risk • delivery • 4. Size of contract • 5. Transaction Costs

  12. 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. FUTURES CONTRACTS

  13. PART II Currency Options

  14. CURRENCY OPTIONS • I. OPTIONS • A. Currency options • 1. offer another method to hedge exchange rate risk. • 2. first offered on Philadelphia • Exchange (PHLX).

  15. 3. HOW CURRENCY OPTIONS ARE PURCHASED Premium • Buyers Sellers=Writers Sell Buy Sell Buy PUT CALL

  16. 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.

  17. 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.

  18. 6. What is the premium? • the price of an option that the writer charges the buyer.

  19. 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.

  20. 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

  21. CURRENCY OPTIONS • 8. Status of an option • a. In-the-money • Call: Spot > strike • Put: Spot < strike • b. Out-of-the-money • Call: Spot < strike • Put: Spot > strike • c. At-the-money • Spot = the strike

  22. 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.

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