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chapter11 - CHAPTER 11 Foreign Exchange Futures In this...

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Chapter 11 1 CHAPTER 11 Foreign Exchange Futures In this chapter, we discuss foreign exchange futures. This chapter is organized as follows: 1. Price Quotations 2. Geographical and Cross-Rate Arbitrage 3. Forward and Futures Market Characteristics 4. Determinants of Foreign Exchange Rates 5. Futures Price Parity Relationships 6. Speculation in Foreign Exchange Futures 7. Hedging with Foreign Exchange Futures
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Chapter 11 2 Price Quotation In the foreign exchange market, every price is a relative price. That is, there is a reciprocal rate. Example: To say that $1 = € 2.5 (2.5 euros) implies that € 2.5 will buy $1 Or € 1 = $0.40 Figure 11.1 shows foreign exchange rate quotations as they appear in the Wall Street Journal.
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Chapter 11 3 Price Quotation Insert Figure 11.1 here
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Chapter 11 4 Price Quotation Forward rates are the rates that you can contract today for the currency. If you buy a forward rate, you agree to pay the forward rate in 30 days to receive the currency in question. If you sell a forward rate, you agree to deliver the currency in question in receipt of the forward rate. The transactions are in the interbank market. The transactions are for $1,000,000 or more. One rate is the inverse of the other (e.g., $/€ reverse of €/ $). Using the previous example $1 = €2.5 rate S U rate rate S U .$ . / 1 / .$ . = 5 . 2 1 / .$ . = rate S U 40 . 0 / .$ . = rate S U rate rate US rate US rate / $ 1 $ / = 40 . 0 1 $ / = rate US rate 50 . 2 $ / = rate US rate
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Chapter 11 5 CME’s Euro FX Futures Product Profile Product Profile: The CME = s Euro FX Futures Contract Size: 125,000 Euro Deliverable Grades: N/A Tick Size: 0.0001=$12.50 Price Quote: U.S dollars per Euro. Contract Months: Six months in the March, June, September, and December cycle Expiration and final Settlement: Eurodollar futures cease trading at 9:16 a.m. Chicago Time on the second business day immediately preceding the third Wednesday of the contract month. The contract is physically settled. Trading Hours: Floor: 7:20 a.m.- 2:00 p.m ; Globex: Mon/Thurs 5:00 p.m.- 4:00 p.m.; Shutdown period from 4:00 p.m. to 5:00 p.m. nightly; Sunday & holidays 5:00 p.m.-4:00 p.m. Daily Price Limit: None
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Chapter 11 6 Geographical and Cross-Rate Arbitrage Pricing relationships exist in the foreign exchange market. This sections explores two of these relationships and associated arbitrage opportunities: 1. Geographical Arbitrage 2. Cross-Rate Arbitrage
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Chapter 11 7 Geographical Arbitrage Geographical arbitrage occurs when one currency sells for a different prices in two different markets. Example Suppose that the following exchange rates exist between German marks and U.S. dollars as quoted in New York and Frankfurt for 90-day forward rates: New York $/€ 0.42 Frankfurt €/$ 2.35 To identify the opportunity for an arbitrage we can compute the inverse. From the price in New York, we can compute the appropriate exchange rate in Frankfurt.
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