{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Chapter 23_Hand-out 17

Chapter 23_Hand-out 17 - CHAPTER 23 FUTURES SWAPS AND RISK...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
CHAPTER 23 FUTURES, SWAPS AND RISK MANAGEMENT 23.1 FOREIGN EXCHANGE FUTURES Hedging refers to techniques that offset particular sources of risk, rather than as a more ambitious search for an optimal risk-return profile for an entire portfolio. Because futures contracts are written on particular quantities such as stock index values, foreign exchange rates, commodity prices, and so on, they are ideally suited for these applications. 1. The Markets Exchange rates between currencies vary continually and often substantially. This variability can be a source of concern for anyone involved in international business. Any U.S. exporter is exposed to foreign exchange rate risk. This risk can be hedged through currency futures or forward markets. For example, if you know you will receive 100,000 pounds in 90 days, you can sell those pounds forward today in the forward market and lock in an exchange rate equal to today’s forward price. The forward market in foreign exchange is fairly informal. It is simply a network of banks and brokers that allows customers to enter forward contract to purchase or sell currency in the future at a currently agree-upon rate of exchange. The bank market in currencies is among the largest in the world, and most large traders with sufficient creditworthiness execute their trades here rather than in futures markets. Unlike those in futures markets, contracts in forward markets are not standardized in a formal market setting. Instead, each is negotiated separately. Moreover, there is no marking to market, as would occur in futures markets. Currency forward contracts call for execution only at the maturity dale. For currency futures , however, there are formal markets on exchanges such as the Chicago Mercantile Exchange (International Monetary Market) or the London International Financial Futures Exchange. Here contracts are standardized by size, and daily marking to market is observed. Figure 16.6 in the textbook reproduces The Wall Street Journal listing of foreign exchange spot and forward rates. The listing gives the number of U.S. dollars required to purchase some unit of foreign currency and then the amount of foreign currency needed to purchase $1. Both spot and forward exchange rates are listed for various delivery dates. 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
2. Interest Rate Parity As is true of stocks and stock futures, there is a spot-futures exchange rate relationship that will prevail in well-functioning markets. Should this so- called interest rate parity relationship be violated, arbitrageurs will be able to make risk-free profits in foreign exchange markets with zero net investment. Their actions will force futures and spot exchange rate back into alignment. We can illustrate the interest rate parity theorem by using two currencies, the U.S dollar and the British (U.K.) pound. Call E 0 the exchange rate between the two currencies, that is, E 0 dollars are required to purchase one pound. F 0 , the forward price, is the number of dollars that is agreed to today for purchase of one pound at time T in the future. Call the risk-free rates in the
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 12

Chapter 23_Hand-out 17 - CHAPTER 23 FUTURES SWAPS AND RISK...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon bookmark
Ask a homework question - tutors are online