CHAPTER 7 - CURRENCY FUTURES AND OPTIONS
Opening story on p. 165 of a 31-year old rogue trader in France who took unauthorized positions on
$73 billion worth of European stock index futures that resulted in losses of $7.2 billion when the
market turned downward against the trader’s position (he was betting the market would go up).
Illustrates the extreme danger/volatility of derivatives. Options and futures can be used to eliminate,
reduce, hedge and manage risk, like insurance, but can also be extremely speculative. Why??
MECHANICS OF FUTURES CONTRACTS
Differences/similarities between futures and forward contracts, see summary Exhibit 7.1 on p. 167:
1. Both are
for future delivery/receipt. Agree on P and Q today for future
settlement or delivery in 1 week to 10 years.
2. Both are used to hedge currency risk, interest rate risk or commodity price risk.
3. In principal they are very similar, used to accomplish the same goal of risk management.
1. Forward contracts are private, customized contracts between a bank and its clients (MNCs,
exporters, importers, etc.) depending on the client's needs. There is no secondary market for forward
contracts since it is a private contractual agreement, like most bank loans (vs. bond).
2. Forward contracts are settled at expiration, futures contracts are continually settled, daily
3. Most (90%) of forward contracts are settled with delivery/receipt of the asset. Most futures contracts
(99%) are settled with cash, NOT the commodity/asset.
4. Futures markets have daily price limits.
Currency Futures Contracts are standardized contracts, with fixed, standardized contract sizes and fixed
expiration dates, that are
, i.e., traded as securities on organized exchanges. Futures
contracts have secondary markets, can be traded many times during life of contract, like a bond (vs.
bank loan). See Exhibit 7.2 on p. 170.
Yen contracts: ¥12.5m (approx. $152,000), Pound: £62,500 (approx. $100,000),
Euro: €125,000 (approx $170,000), SF: 125,000 (approx $122,500), etc. Expiration dates: March,
June, Sept, and December on the 3rd Wednesday.
: If you wanted to hedge receipt/payment of £100,000, you would have to either do a partial hedge
of £62,500 (1 contract) or "over-hedge" with 2 contracts for £125,000 total.
MGT 566: International Finance – CH 7
Professor Mark J. Perry