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After completing this chapter, students will be able to: To differentiate among forward, futures and option contracts, to explain how forward contracts are used for hedging based on anticipated exchange rate movements; to explain how currency futures contracts and currency options contracts are used for hedging or speculation based on anticipated exchange rate movements. | Currency Derivatives 7 Lecture Currency Futures Market Enforced by potential arbitrage activities, the prices of currency futures are closely related to their corresponding forward rates and spot rates. Currency futures contracts are guaranteed by the exchange clearinghouse, which in turn minimizes its own credit risk by imposing margin requirements on those market participants who take a position. Currency Futures Market Speculators often sell currency futures when they expect the underlying currency to depreciate, and vice versa. 1. Contract to sell 500,000 pesos @ $.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. Currency Futures Market MNCs may purchase currency futures to hedge their foreign currency payables, or sell currency futures to hedge their receivables. 1. Expect to receive 500,000 pesos. Contract to sell 500,000 pesos @ $.09/peso on June 17. April 4 2. . | Currency Derivatives 7 Lecture Currency Futures Market Enforced by potential arbitrage activities, the prices of currency futures are closely related to their corresponding forward rates and spot rates. Currency futures contracts are guaranteed by the exchange clearinghouse, which in turn minimizes its own credit risk by imposing margin requirements on those market participants who take a position. Currency Futures Market Speculators often sell currency futures when they expect the underlying currency to depreciate, and vice versa. 1. Contract to sell 500,000 pesos @ $.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. Currency Futures Market MNCs may purchase currency futures to hedge their foreign currency payables, or sell currency futures to hedge their receivables. 1. Expect to receive 500,000 pesos. Contract to sell 500,000 pesos @ $.09/peso on June 17. April 4 2. Receive 500,000 pesos as expected. June 17 3. Sell the pesos at the locked-in rate. Currency Futures Market Holders of futures contracts can close out their positions by selling similar futures contracts. Sellers may also close out their positions by purchasing similar contracts. 1. Contract to buy A$100,000 @ $.53/A$ ($53,000) on March 19. January 10 3. Incurs $3000 loss from offsetting positions in futures contracts. March 19 2. Contract to sell A$100,000 @ $.50/A$ ($50,000) on March 19. February 15 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 in the over-the-counter market. Currency Call Options 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
