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Document Title Web Design Group

2596 words - 11 pages

Lecture 5
Chapter 8

Foreign currency derivatives

Lecture outline
Chapter 8: Foreign currency derivatives
Futures contracts Options

Chapter 9: Interest rate and currency swap
Interest rate risk management FRAs Interest rate futures (not examinable) Swaps

Foreign Currency Derivatives
Financial management of the MNE in the 21st century involves financial derivatives. These derivatives, so named because their values are derived from underlying assets, are a powerful tool used in business today. These instruments can be used for two very distinct management objectives:
Speculation – use of derivative instruments to take a position in the expectation of a profit Hedging – use ...view middle of the document...



Foreign Currency Futures
Contract specifications are established by the exchange on which futures are traded. Major features that are standardized are: Contract size Method of stating exchange rates Maturity date Last trading day Collateral and maintenance margins Settlement Commissions Use of a clearinghouse as a counterparty

Foreign Currency Futures vs. Forward contracts
Foreign currency futures contracts differ from forward contracts in a number of important ways: Futures are standardized in terms of size while forwards can be customized Futures have fixed maturities while forwards can have any maturity (both typically have maturities of one year or less) Trading on futures occurs on organized exchanges while forwards are traded between individuals and banks Futures have an initial margin that is market to market on a daily basis while only a bank relationship is needed for a forward Futures are rarely delivered upon (settled) while forwards are normally delivered upon (settled)

FX Futures
Key notes:
Trading positions
Long: Buy the FX in the futures contracts Short: Sell the FX in the futures contracts

Initial margin vs. maintenance margin Marked to market principle Margin call Exit strategy with an offsetting position with the clearing house Price transparency


Lecture example: AUD/USD Futures


AUD/USD futures example

Underlying assets: Motivation: Contract size: Exchange rate quote style: Maturity date: Initial margin: Maintenance margin: Futures price: Change:
Long position: Short position:

AUD/USD futures example
A person got in the long position in the prior trade for one contract. F (prior) = 0.8964

F (last) = 0.8946

Beg. Balance


Ending Balance



AUD/USD futures example
Alternative 1: Physical delivery

Alternative 2: “A round turn”


Foreign Currency Options
A foreign currency option is a contract giving the option purchaser (the buyer) 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 (until the maturity date). There are two basic types of options, puts and calls.
A call is an option to buy foreign currency A put is an option to sell foreign currency

Foreign Currency Options
The buyer of an option is termed the holder, while the seller of the option is referred to as the writer or grantor. Every option has three different price elements:
The exercise or strike price – the exchange rate at which the foreign currency can be purchased (call) or sold (put) The premium – the cost, price, or value of the option itself The underlying or actual spot exchange rate in the market



Foreign Currency Options
An American option gives the buyer the right to exercise the option at any time between the date of writing and the expiration or maturity date. A European option can be exercised only on its expiration date, not before....

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