seminar 4: currency derivatives - future · seminar 4: currency derivatives - future...

Seminar 4:Currency Derivatives - Future

Ayaz Zeynalov, PhD.

University of Economics Prague

9th March 2020

Course: International Financial Management

Office hours: Monday, 10:00-12:00, or by appointment - [email protected]

Office: NB274, Jan Masaryk Centre of International Studies, FIR

Ayaz Zeynalov, PhD. University of Economics Prague 9th March 2020 1 / 20

Overview

Contract SpecificationsTrading FuturesComparison of Currency Futures and Forward ContractsPricing Currency FuturesCredit Risk of Currency Futures ContractsSpeculation with Currency FuturesHow Firms Use Currency Futures?Closing Out a Futures PositionTrading Platforms for Currency Futures


Future Contract

Currency futures are contracts specifying a standard volume of a particularcurrency to be exchanged on a specific settlement date.

Currency futures contracts are similar to forward contracts in terms of theirobligation, but differ from forward contracts in the way they are traded.They are commonly used by MNCs to hedge their foreign currency positions.They are also traded by speculators who hope to capitalize on theirexpectations of exchange rate movements.A buyer of a currency futures contract locks in the exchange rate to be paidfor a foreign currency at a future point in time.A seller of a currency futures contract locks in the exchange rate at which aforeign currency can be exchanged for the home currency.


Contract Specifications

Currency futures contracts are available for several widely traded currenciesat the Chicago Mercantile Exchange (CME) Group. See

The contract for each currency specifies a standardized number of units.

The typical currency futures contract is based on a currency value in terms ofU.S. dollars.

Futures contracts are also available on some cross-rates.


https://www.cmegroup.com/trading/fx/

Currency Futures vs Forward Contracts


CME Group - FX Products


Equity Index Products

See


https://www.cmegroup.com/trading/equity-index/

Trading future

Firms or individuals can execute orders for currency futures contracts bycalling brokerage firms that serve as intermediaries.The order to buy or sell a currency futures contract for a specific currencyand a specific settlement date is communicated to the brokerage firm.

Example

Assume that as of February 10, a future contract on £62,500 with a Marchsettlement date is priced at $1.50 per pound.

The buyer of this currency futures contract will receive £62,500 on the Marchsettlement date and will pay $93,750 for the pounds (computed as £62,500 x$1.50 per pound plus a commission paid to the broker).The seller of this contract is obligated to sell £62,500 at a price of $1.50 perpound and therefore will receive $93,750 on the settlement date, minus thecommission that it owes the broker


Pricing Currency Futures

The price of currency futures normally is similar to the forward rate for a givencurrency and settlement date.

Example

Assume that the currency futures price on the British pound is $1.50 and thatforward contracts for a similar period are available for $1.48.

Firms may attempt to purchase forward contracts and simultaneously sellcurrency futures contracts.If they can exactly match the settlement dates of the two contracts, they cangenerate guaranteed profits of $0.02 per unit.These actions will place downward pressure on the currency futures price.The futures contract and forward contracts of a given currency andsettlement date should have the same price, or else guaranteed profits arepossible (assuming no transaction costs).


Pricing Currency Futures

Practice 1

The table below is an excerpt of futures prices. Use this table to answer questions.

1 What are the CME contracts size for Japanese yen, New Zealand Dollar,Swiss Franc?

2 What are the open interests for the September contracts for all three?3 What are the daily high, low, and settlement prices for the December

contracts for all three?4 What is the day’s cash flow from marking to market for the holder of a NZD

June contract?


Speculation with Currency Futures

Currency futures contracts are purchased by speculators who are simplyattempting to capitalize on their expectation of a currency’s future movement.

Example

Assume that speculators expect the British pound to appreciate in the future:

1 They can purchase a futures contract that will lock in the price at which theybuy pounds at a specified settlement date.

2 On the settlement date, they can purchase their pounds at the rate specifiedby the futures contract and then sell these pounds at the spot rate.

3 If the spot rate has appreciated by this time in accordance with theirexpectations, they will profit from this strategy.

Currency futures are often sold by speculators who expect that the spot rate of acurrency will be less than the rate at which they would be obligated to sell it.



Practice 2

On the morning of Monday, August 21, you purchased a futures contract for 1unit of CHF at a rate of USD/CHF 0.7. The subsequent settlement prices areshown in the table below.

August 21 22 23 24 25 28 29 30Future rate 0.71 0.70 0.72 0.71 0.69 0.68 0.66 0.63

1 What are the daily cash flows from marking to market?2 What is the cumulative total cash flow from marking to market (ignoring

discounting)?3 Is the total cash flow greater than, less than, or equal to the difference

between the price of your original futures contract and the price of the samefutures contract on August 30?



Example

Assume that as of April 4, a futures contract specifying 500,000 Mexican pesosand a June settlement date is priced at $.09.

On April 4, speculators who expect the peso will decline sell futures contractson pesos.On June 17 (the settlement date), the spot rate of the peso is $.08.When selling the pesos in accordance with the futures contract, the amountreceived - $45,000.The pesos in the spot market, the amount paid - $40,000.The gain on the futures position is $5,000.


Currency Futures Market Efficiency

Example

If the currency futures market is efficient, the futures price for a currency at anygiven point in time should reflect all available information.

Some positions will likely result in gains while others will result in losses, butover time, the gains and losses should offset.Research suggests that the currency futures market may be inefficient:available information.

Credit Risk of Currency Futures Contracts

To minimize its risk, the CME imposes margin requirements to coverfluctuations in the value of a contract, meaning that the participants mustmake a deposit with their respective brokerage firms when they take aposition.


How Firms Use Currency Futures?

Purchasing Futures to Hedge Payables:

Teton Co. orders Canadian goods and upon delivery will need to send C $500,000to the Canadian exporter.

Thus, Teton purchases Canadian dollar futures contracts today, therebylocking in the price to be paid for Canadian dollars at a future settlementdate.By holding futures contracts, Teton does not have to worry about changes inthe spot rate of the Canadian dollar over time

Selling Futures to Hedge Receivables:

Karla Co. sells futures contracts when it plans to receive a currency fromexporting that it will not need.It accepts a foreign currency when the importer prefers that type of payment.

By selling a futures contract, Karla Co. locks in the price at which it will beable to sell this currency as of the settlement date.Such an action can be appropriate if Karla expects the foreign currency todepreciate against Karla’s home currency.


Closing Out a Futures Position

Example

January 10, Tacoma Co. anticipates that it will need Australian dollars (A$) inMarch when it orders supplies from an Australian supplier.Consequently, Tacoma purchases a futures contract specifying A$100,000 and aMarch settlement date (which is March 19 for this contract).

On January 10, the futures contract is priced at $.53 per A$.On February 15, Tacoma realizes that it will not need to order suppliesbecause it has reduced its production levels: it has no need for A$ in March.It sells a futures contract to offset the contract. At this time, the futurescontract is priced at $.50 per A$.On March 19 (the settlement date), Tacoma has offsetting positions in futurescontracts.Tacoma incurs a loss from its futures positions.


Hedging with Currency Derivatives

Practice 3

Specify wherever you see possible ways to hedge each of the transactions. If so,whether it is Future or Forward, and Purchase or Sell?

George ltd plans to purchase Japanese goods denominated in yen.Harvard ltd sold goods to Japan, denominated in yen.Yale plc has a subsidiary in Australia that will be remitting funds to the U.S.parent.Brown ltd needs to pay off existing loans that are denominated in Canadiandollars.Princeton ltd may purchase a company in Japan in the near future (but thedeal may not go through).


Currency Swaps

A currency swap, sometimes referred to as a cross-currency swap, involves theexchange of interest and sometimes of principal in one currency for the same inanother currency.A currency swap enables firms to exchange currencies at periodic intervals.

Example:

Miller Co., a U.S. firm, desires to issue a bond denominated in Euros becauseit could make payments with Euro inflows to be generated from existingoperations.However, Miller Co. is not well known to investors who would considerpurchasing euro-denominated bonds.Meanwhile Beck Co. of Germany desires to issue dollar-denominated bondsbecause its inflow payments are mostly in dollars.However, it is not well known to the investors who would purchase thesebonds.


Currency Swaps


The End

Thanks for your attention!Questions?


seminar 4: currency derivatives - future · seminar 4: currency derivatives - future...

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