Transcript CHAPTER 8 Currency Futures and Options Markets

CHAPTER 8
Currency Futures and
Options Markets
PART I
Futures Contracts
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
FUTURES CONTRACTS
B. International Monetary Market
(IMM) 1972:
opened by the Chicago Mercantile
Exchange
Purpose:
to provide a stable market for the
exchange of currency futures.
FUTURES CONTRACTS
2. IMM provides
a.
an outlet for hedging currency
risk with futures contracts.
Definition of a Futures Contract:
contracts written requiring a
standard quantity of an available
currency at a fixed exchange rate
at a set delivery date.
FUTURES CONTRACTS
b. Available Futures Contracts
Currency/ Contract Size:
1.) British pound
2.)
3.)
4.)
5.)
6.)
7.)
/ 62,500
Canadian dollar /100,000
Euro / 125,000
Swiss franc / 125,000
Japanese yen / 12.5 million
Mexican peso / 500,000
Australian dollar / 100,000
FUTURES CONTRACTS
c. Transaction costs:
in the form of a commission payment to a
floor trader
d. Leverage is high
1.)
Initial margin required is
relatively low (less than 2% of
contract value).
FUTURES CONTRACTS:
SAFEGUARDS
e. Maximum price movement
rules:
Contracts set daily to a price
limit that restricts maximum
daily upward and downward
movements.
FUTURES CONTRACTS:
SAFEGUARDS
f. Maintenance Margins:
When the account balance falls below
the maintenance margin, a margin call
may be necessary to maintain the
minimum balance.
FUTURES CONTRACTS
g. Global futures exchanges:
1.)
2.)
3.)
4.)
5.)
6.)
I.M.M. International Monetary
Market
L.I.F.F.E.London International
Financial Futures Exchange
C.B.O.T. Chicago Board of Trade
S.I.M.E.X.Singapore International
Monetary Exchange
D.T.B. Deutsche Termin Bourse
H.K.F.E. Hong Kong Futures
Exchange
FUTURES CONTRACTS
B. Forward vs. Futures Contracts
Basic differences:
1. Trading Locations 6. Quotes
2. Regulation
7. Margins
3. Frequency of
8. Credit risk
delivery
4. Size of contract
5. Transaction Costs
FUTURES CONTRACTS
Advantages of
futures:
1.) Easy liquidation
2.) Well- organized
and stable
market.
Disadvantages of
futures:
1.) Limited to 7
currencies
2.) Limited dates
of delivery
3.) Rigid contract
sizes.
PART II
Currency
Options
CURRENCY OPTIONS
I. OPTIONS
A. Currency options
1.
offer another method to
hedge exchange rate risk.
2.
first offered on Philadelphia
Exchange (PHLX).
3. HOW CURRENCY OPTIONS ARE
PURCHASED
Premium
Buyers
Buy
Sellers=Writers
Sell
PUT
CALL
Buy
Sell
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.
CURRENCY OPTIONS
5. Expiration Dates of Currency
Options:
a.
b.
American
exercise date may occur any
time up to the expiration date.
European
exercise date occurs only at the
expiration date and not before.
6. What is the premium?
the price of an option that the writer
charges the buyer.
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.
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
CURRENCY OPTIONS
8. Status of an option
a.
b.
c.
In-the-money
Call: Spot > strike
Put: Spot < strike
Out-of-the-money
Call: Spot < strike
Put: Spot > strike
At-the-money
Spot = the strike
CURRENCY OPTIONS
9. Why Use Currency Options?
1.
For the firm hedging foreign
exchange risk when a future event is
very uncertain.
2.
For speculators
who profit from favorable
exchange rate changes.