1 Multinational Financial Management Alan Shapiro 10 th Edition John Wiley & Sons, Inc. PowerPoints by Joseph F. Greco, Ph.D. California State University, Fullerton

CHAPTER 8 Currency Futures and Options Markets

PART I Futures Contracts 3

4 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

5 FUTURES CONTRACTS d. International Monetary Market (IMM) 1972: opened by the Chicago Mercantile Exchange Purpose: to provide a stable market for the exchange of currency futures. 5

6 FUTURES CONTRACTS 2.IMM provides a.an outlet for hedging currency risk with futures contracts. b. Definition of a Futures Contract: contract written requiring three things: a standard quantity of an available currency at a fixed exchange rate at a set delivery date. 6

7 FUTURES CONTRACTS c.Available Futures Contracts: - in over 20 different currencies - cross-rate contracts 7

8 FUTURES CONTRACTS d.Transaction costs: in the form of a commission payment to a floor trader e.Leverage is high: Initial margin required is relatively low (less than 2% of contract value) 8

9 FUTURES CONTRACTS: SAFEGUARDS f.Maximum price movement rules: Contracts set daily to a price limit that restricts maximum daily upward and downward movements 9

10 FUTURES CONTRACTS: SAFEGUARDS g. Maintenance Margins: When the account balance falls below the maintenance margin, a margin call may be necessary to maintain the minimum balance. 10

11 FUTURES CONTRACTS h.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

12 FUTURES CONTRACTS B.Forward vs. Futures Contracts Basic differences: 1. Trading Locations6. Quotes 2. Regulation7. Margins 3. Frequency of 8. Credit risk delivery 4. Size of contract 5. Transaction Costs 12

13 FUTURES CONTRACTS C. Advantages of futures: 1. Easy liquidation 2. Well- organized and stable market. Disadvantages of futures: 1. Limited to a few currencies 2. Limited dates of delivery 3. Rigid contract sizes. 13

PART II Currency Options 14

15 CURRENCY OPTIONS I.OPTIONS A. Currency options 1.offer another method to hedge exchange rate risk 2.first offered on Philadelphia Exchange (PHLX) 15

16 HOW CURRENCY OPTIONS ARE PURCHASED 1. Overview: BuyersSellers=Writers Buy SellBuySell CALL PUT Premium 16

17 CURRENCY OPTIONS 2. 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

18 CURRENCY OPTIONS 3.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

19 CURRENCY OPTIONS 4.What is the premium? the price of an option that the writer charges the buyer 19

20 CURRENCY OPTIONS 5.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

21 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

22 CURRENCY OPTIONS 6.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

23 CURRENCY OPTIONS 7. Why Use Currency Options? a.For the firm hedging foreign exchange risk when a future event is very uncertain. b.For speculators who profit from favorable exchange rate changes. 23

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