Midterm Review 2

Midterm Review 2 - CH 8 Foreign Currency Derivatives...

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CH 8 – Foreign Currency Derivatives – foreign currency futures contract - It calls for future delivery of a standard amount of currency at a fixed time and price. These contracts are traded on exchanges, largest being the International Monetary Market located in the Chicago Mercantile Exchange . Size of contract – called the notional principal, trading in each currency must be done in an even multiple. Method of stating exchange rates – “American terms” are used; quotes are in US dollar cost per unit of foreign currency, also known as direct quotes. Maturity date – contracts mature on the 3rd Wednesday of January, March, April, June, July, September, October or December. Last trading day – contracts may be traded through the second business day prior to maturity date. – the purchaser or trader must deposit an initial margin or collateral; this requirement is similar to a performance bond. At the end of each trading day, the account is marked to market and the balance in the account is either credited if value of contracts is greater or debited if value of contracts is less than account balance. Settlement – only 5% of futures contracts are settled by physical delivery, most often buyers and sellers offset their position prior to delivery date. The complete buy/sell or sell/buy is termed a round turn. Commissions customers pay a commission to their broker to execute a round turn and only a single price is quoted. Use of a clearing house as a counterparty – All contracts are agreements between the client and the exchange clearing house. Consequently clients need not worry about the performance of a specific counterparty since the clearing house is guaranteed by all members of the exchange. A foreign currency option is a contract giving the purchaser of the option the right, but not the obligation to buy or sell a given amount of currency at a fixed price per unit for a specified time period. Two basic types of options, calls – buyer has right to purchase currency and puts – buyer has right to sell currency. The buyer of the option is the holder and the seller of the option is termed the writer. Every option has three different price elements: The strike or exercise price is the exchange rate at which the foreign currency can be purchased or sold. The premium , the cost, price or value of the option itself paid at time option is purchased. The underlying or actual spot rate in the market. There are two types of option maturities: American options may be exercised at any time during the life of the option. European options may not be exercised until the specified maturity date. Options may also be classified as per their payouts: At-the-money (ATM) options have an exercise price equal to the spot rate of the underlying currency. In-the- money (ITM) options may be profitable, excluding premium costs, if exercised immediately. Out-of-the-money (OTM) options would not be profitable, excluding the premium
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This note was uploaded on 09/08/2010 for the course BUS 177 at San Jose State.

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Midterm Review 2 - CH 8 Foreign Currency Derivatives...

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