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IFM_IM_ch05 - Chapter 5 Currency Derivatives Lecture...

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Chapter 5 Currency Derivatives Lecture Outline Forward Market How MNCs Use Forward Contracts Non-Deliverable Forward Contracts Currency Futures Market Contract Specifications Trading Futures Comparison of Currency Futures and Forward Contracts Pricing Currency Futures Credit Risk of Currency Futures Contracts Speculation with Currency Futures How Firms Use Currency Futures Closing Out a Futures Position Trading Platforms for Currency Futures Currency Options Market Options Exchanges Over-the-Counter Market Currency Call Options Factors Affecting Currency Call Option Premiums How Firms Use Currency Call Options Speculating with Currency Call Options Currency Put Options Factors Affecting Currency Put Option Premiums Hedging with Currency Put Options Speculating with Currency Put Options Contingency Graphs for Currency Options Contingency Graph for a Purchaser of a Call Option Contingency Graph for a Buyer of a Put Option Contingency Graph for a Seller of a Put Option Conditional Currency Options European Currency Options 50
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Chapter Theme This chapter provides an overview of currency derivatives, which are sometimes referred to as “speculative.” Yet, firms are increasing their use of these instruments for hedging purposes. The chapter does give speculation some attention, since this is a good way to illustrate the use of a particular instrument based on certain expectations. However, the key is that students have an understanding why firms would consider using these instruments and under what conditions they would use them. Topics to Stimulate Class Discussion 1. Why would a firm ever consider futures contracts instead of forward contracts? 2. What advantage do currency options offer that are not available with futures or forward contracts? 3. What are some disadvantages of currency option contracts? 4. Why do currency futures prices change over time? 5. Why do currency options prices change over time? 6. Set up several scenarios, and for each scenario, ask students to determine whether it would be better for the firm to purchase (or sell) forward contracts, futures contracts, call option contracts, or put options contracts. POINT/COUNTER-POINT: Should Speculators Use Currency Futures or Options? POINT: Speculators should use currency futures because they can avoid a substantial premium. To the extent that they are willing to speculate, they must have confidence in their expectations. If they have sufficient confidence in their expectations, they should bet on their expectations without having to pay a large premium to cover themselves if they are wrong. If they do not have confidence in their expectations, they should not speculate at all. COUNTER-POINT: Speculators should use currency options to fit the degree of their confidence. For example, if they are very confident that a currency will appreciate substantially, but want to limit their investment, they can buy deep out-of-the-money options. These options have a high exercise price but a low premium, and therefore require a small investment. Alternatively, they can buy options that
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