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CHAPTER 6 CURRENCY FUTURES AND OPTIONS MARKETS
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CHAPTER OVERVIEW CHAPTER OVERVIEW I.FUTURES CONTRACTS II.CURRENCY OPTIONS
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PART I. FUTURES CONTRACTS I.CURRENCY FUTURES A.Background 1.1972: Chicago Mercantile Exchange opens International Monetary Market. (IMM)
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FUTURES CONTRACTS 2.IMM provides a.an outlet for hedging currency risk with futures contracts. b.Definition: contracts written requiring a standard quantity of an available currency at a fixed exchange rate at a set delivery date.
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FUTURES CONTRACTS c.Available Futures Currencies: 1.) British pound5.) French franc 2.) Canadian dollar6.) Japanese yen 3.) German mark7.) Australian 4.) Swiss francdollar
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FUTURES CONTRACTS d.Standard Quantity of Currency contract quantity sizes differ for each of the 7 available currencies. Example German mark = DM125,000
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FUTURES CONTRACTS e.Transaction costs: payment of commission to a trader f.Leverage is high 1.)Initial margin required is relatively low (less than 2% of contract value).
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FUTURES CONTRACTS g.Maximum price movements 1.)Contracts set to a daily price limit restricting maximum daily price movements.
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FUTURES CONTRACTS 2.)If limit is reached, a margin call may be necessary to maintain a minimum margin.
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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
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FUTURES CONTRACTS 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
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FUTURES CONTRACTS B.Forward vs. Futures Contracts Basic differences: 1. Trading Locations6. Settlement Date 2. Regulation7. Quotes 3. Frequency of 8. Transaction delivery costs 4. Size of contract9. Margins 5. Delivery dates 10. Credit risk
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FUTURES CONTRACTS Advantages of futures: 1.) Smaller contract size 2.) Easy liquidation 3.) Well- organized and stable market. Disadvantages of futures: 1.) Limited to 7 currencies currencies 2.) Limited dates of delivery of delivery 3.) Rigid contract sizes. sizes.
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PART II CURRENCY OPTIONS I.OPTIONS A. Currency options 1.offer another method to hedge exchange rate risk. 2.first offered on Philadelphia Exchange (PHLX). 3.fastest growing segment of the hedge markets.
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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.
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CURRENCY OPTIONS 5.Types 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.
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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.
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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
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CURRENCY OPTIONS 9.The premium: the price of an option that the writer charges the buyer.
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CURRENCY OPTIONS B.Using Currency Options 1.For the firm hedging foreign exchange risk a. With sizable unrealized gains. b. With foreign currency flows forthcoming.
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CURRENCY OPTIONS 2.For speculators - profit from favorable exchange rate changes.
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CURRENCY OPTIONS C.Option Pricing and Valuation 1. Value of an option equals a. Intrinsic value b. Time value
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CURRENCY OPTIONS 2.Intrinsic Value the amount in-the-money 3.Time Value the amount the option is in excess of its intrinsic value.
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CURRENCY OPTIONS 4.Other factors affecting the value of an option a.value rises with longer time to expiration. b.value rises when greater volatility in the exchange rate.
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CURRENCY OPTIONS 5.Value is complicated by both the home and foreign interest rates.
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CURRENCY OPTIONS D. Using Forward or Futures Contracts: Forward and futures contracts are more suitable for hedging a known amount of foreign currency flow.
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CURRENCY OPTIONS E.Market Structure 1.Location a. Organized Exchanges b. Over-the-counter 1.) Two levels retail and wholesale
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