1. Chapter 4
Currency
Derivatives

2. Forward Contract
“An agreement between a commercial bank and a client about an exchange of two currencies to be made at a future point in time at a specified exchange rate”
Forward rate:
“ Rate at which a bank is willing to exchange one currency for another at some specified date in future”

3. Long Position:
It implies that the holder of contract has agreed to buy the currency
Short Position:
It implies that the holder of contract has agreed to sell the currency

4. Forwards have no secondary market
It means holder can not get out of the commitment
He can not sell the contract
What he can do?
He can enter into another contract of the same
maturity date
So that he can offset the contract
But the contract can not be cancelled

5. Example A firm enters into the contract to buy INR 100000
@ forward rate of PKR 1.50
On maturity date if the spot increases to 1.70
He will buy PKR 1.50
1.50 *
He will pay = PKR
spot PKR 1.70
He had to pay
Profit = 20000

6. Calculation of Points INR / PKR: 1.50/1.60
3-months: 30/ (High / Low = Subtract)
i.e
- .20
1.40
3-months: 20/ (Low/High = Add)
+ .30
1.90

7. Forward-Forward Swap It’s a contract between two forward dates Eg:
combined with
One month
forward sale
Three month
forward purchase

8. Example Suppose 6-month swap points may be favorable
GBP/USD spot: /90
1-month 20/10
2-month 30/20
3-month 40/30
6-month 40/30
12-month 30/20
EXPECTATIONS
After 6-months
GBP rates may fluctuate in future (6-months)
6-month swap points may be favorable

9. Q. How can he profit from this forecast
Buy 12 months forward sterling 5 million
--- six month later when GBP value has changed
Sell 6 months forward sterling
After 6 months
Suppose rates are:
GBP/USD spot: /95
6 months: 40/60

10. Calculation Suppose rates are: FIRST:
He can buy 12-month forward GBP
Suppose rates are:
GBP/USD spot: /90
12-months: 30/20
After selecting Ask price of
Subtract 20 points from last digits (H/L=Subtract)
i.e
- 20
1.7570

11. Calculation Suppose rates are: Second
He can sell 6-month forward GBP
Suppose rates are:
GBP/USD spot: /95
6-months: 40/60
After selecting Bid price of
Add 40 points in last digits (L/H = Add)
i.e
+ 40
1.7625

12. Calculation Gain: 0.0055 * 5m = $ 27500
He sold month forward GBP
He bought 12-month forward GBP
Gain $ /GBP
Gain: * 5m = $ 27500

13. Risk After 6 months If the GBP Depreciates than….. Suppose
GBP/USD Spot: /05
6-month: 40/60
He will
i.e
loss
Therefore a loss of: * 5m = ????

14. Example On day 1 do two swaps Buy GBP 5 m spot
Sell 5 m GBP 6-months forward
and
Sell GBP 5 m spot
Buy 5 m GBP 12-months forward
Suppose both are a spot rate of

15. Calculation Suppose both are done @ a spot rate of 1.7580
First: Sell 6-months forward
If the points are 40/30
GBP/USD spot:
- 40
1.7540
Second: Buy 12-months forward
If the points are 30/20
- 20
1.7560

16. On day 1 The planned cash flows are:
Sell Spot 5m
BUY forward
12-months
+ GBP
- USD )
Buy Spot 5m
SELL forward
6-months
- GBP USD )

17. Calculation 6-months later GBP has fluctuated Suppose
GBP/USD Spot:
6-months: 80/ (L/H:Add)
Now
Buy GBP 5m
Sell GBP 5m 6-months

18. After 6-months The planned cash flows are:
SPOT BUY
+ GBP
- USD )
SELL Forward
6-months
- GBP
+ USD )

19. Matching cash flows + USD 8770000 - USD 8780000 - USD 8502500
267500
Total Gain:
- USD )
+ USD )
237500
30000

20. Discount or Premium Forward Discount:
Percentage by which the forward rate is less than the spot rate
Forward Premium
Percentage by which the forward rate is more than the spot rate

21. Testing Question You expect that the USD will fluctuate in future
(in 3-months)
Suppose the rates are:
USD / INR Spot: / 42.93
1-month 50/40
2-month 60/50
3-month 70/60
6-month 75/65
9-month 90/80

22. You can do two swaps
Buy USD 2 hundred thousand spot
Sell USD 2 hundred thousand 3-months forward
and
Sell USD 2 hundred thousand spot
Buy USD 2 hundred thousand 9-months forward
Suppose both swaps are a spot rate of 42.93

23. After 3-months USD has fluctuated
Suppose
USD / INR Spot: 43.90
6-months: 85/95
Now
Buy USD 2 hundred thousand spot
Sell USD 2 hundred thousand 6-months forward
Calculate the profit/loss at the end of the day