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Currency Futures and Options Markets. International Finance. Dr. A. DeMaskey. Learning Objectives. What are currency futures contacts? How are they quoted, valued, and used for hedging purposes? How do currency futures differ from currency forwards?

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Currency Futures and Options Markets


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currency futures and options markets

Currency Futures and Options Markets

International Finance

Dr. A. DeMaskey

learning objectives
Learning Objectives
  • What are currency futures contacts? How are they quoted, valued, and used for hedging purposes?
  • How do currency futures differ from currency forwards?
  • What are currency option contracts? How are they quoted, valued, and used for hedging purposes?
foreign currency derivatives
Foreign Currency Derivatives
  • Financial management in the 21st century needs to consider the use of financial derivatives
  • These derivatives, so named because their values are derived from the underlying asset, are a powerful tool used for two distinct management objectives:
    • Speculation
    • Hedging
foreign currency derivatives4
Foreign Currency Derivatives
  • In the wrong hands, derivatives can cause a corporation to collapse (Barings, Allied Irish Bank), but used wisely they allow a financial manager the ability to plan cash flows
  • The financial manager must first understand the basics of the structure and pricing of these tools.
  • The derivatives that will be discussed are:
    • Foreign Currency Futures
    • Foreign Currency Options
foreign currency futures
Foreign Currency Futures
  • A foreign currency futures contract is an alternative to a forward contract.
    • It calls for future delivery of a standard amount of currency at a fixed time and price.
    • These contracts are traded on exchanges with the largest being the International Monetary Market located in the Chicago Mercantile Exchange.
contract specifications
Contract size

Method of stating exchange rate

Maturity dates

Last trading date

Collateral and maintenance margin

Settlement

Commission

Clearing Operations

Contract Specifications
using foreign currency futures
Using Foreign Currency Futures
  • Hedging
  • Speculating
  • Forward-Futures Arbitrage
forward contracts versus futures contracts
Trading

Regulation

Frequency of delivery

Size of contract

Delivery date

Settlement

Pricing

Quotes

Transaction costs

Collateral

Credit risk

Clearing Operation Location

Liquidity

Forward Contracts versus Futures Contracts
foreign currency options
Foreign Currency Options
  • A foreign currency option is a contract giving the option holder the right, but not the obligation, to buy or sell a given amount of foreign exchange at a fixed price per unit for a specified time period.
    • Call Option vs. Put Option
    • Holder vs. Grantor
foreign currency options terminology
Every option has three different price elements

Strike or exercise price

Option premium

The underlying or actual spot rate in the market

There are two types of option maturities

American options

European options

Options may also be classified as per their payouts

At-the-money

In-the-money (ITM)

Out-of-the-money (OTM) options

Foreign Currency Options Terminology
market structure
Market Structure
  • Over-the-Counter (OTC) Market
    • Main advantage is that they are tailored to purchaser
    • Counterparty risk exists
    • Mostly used by individuals and banks
  • Organized Exchanges
    • The Chicago Mercantile
    • Philadelphia Stock Exchange
    • Options Clearinghouse Corporation (OCC)
using foreign currency options
Using Foreign Currency Options
  • Users
    • Financial Firms
    • Corporations
  • Hedging
  • Speculating
option pricing and valuation
Option Pricing and Valuation
  • An option’s value consists of two parts:
    • Intrinsic Value
    • Time Value
  • Intrinsic Value is the amount by which an option is in-the-money.
  • Time Value is the amount by which an option’s value exceeds its intrinsic value.
option pricing model
Option Pricing Model
  • The value of a currency option depends on the following five variables:
    • Strike price relative to the spot exchange rate
    • Time to maturity
    • Relative interest rates between the two currencies
    • Volatility of underlying currency
    • Supply and demand for specific option
online application
Online Application
  • Visit the Commodity Futures Trading Commission at http://www.cftc.gov/.
  • The Options Clearing Corporation at http://www.optionsclearing.com/
  • The Chicago Mercantile Exchange provides current and historical futures and option prices at http://www.cme.com/prices/index.cfm.
  • The Chicago Board Options Exchange at http://www.cboe.com, and
  • The London International Financial Futures and Options Exchange at www.liffe.com.