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Unformatted text preview: Chapter 8 Foreign Currency Derivatives Questions 8-1. Options versus Futures. Explain the difference between foreign currency options and futures and when either might be most appropriately used. An option is a contract giving the buyer the right but not the obligation to buy or sell a given amount of foreign exchange at a fixed price for a specified time period. A future is an exchange- traded contract calling for future delivery of a standard amount of foreign currency at a fixed time, place, and price. The essence of the difference is that an option leaves the buyer with the choice of exercising or not exercising. The future requires a mandatory delivery. The future is a standardized exchange-traded contract often used as an alternative to a forward foreign exchange agreement. 8-2. Trading Location for Futures. Check The Wall Street Journal to find where in the United States foreign exchange future contracts are traded. The Wall Street Journal reports on foreign exchange futures trading for the International Monetary Market in Chicago and for the Philadelphia Stock Exchange. These are the two major U.S. markets for foreign exchange futures. 8-3. Futures Terminology. Explain the meaning and probable significance for international business of the following contract specifications: Specific-sized contract. Trading may be conducted only in preestablished multiples of currency units. This means that a firm wishing to hedge some aspect of its foreign exchange risk is not able to match the contract size with the size of the risk. Standard method of stating exchange rates . Rates are stated in “American terms,” meaning the U.S. dollar value of the foreign currency, rather than in the more generally accepted “European terms,” meaning the foreign currency price of a U.S. dollar. This has no conceptual significance, although financial managers used to viewing exposure in European terms will find it necessary to convert to reciprocals. Standard maturity date . All contracts mature at a preestablished date, being on the third Wednesday of eight specified months. This means that a firm that wishes to use foreign exchange futures to cover exchange risk will not be able to match the contract maturity with the risk maturity. 34 Eiteman/Stonehill/Moffett • Multinational Business Finance, Twelfth Edition Collateral and maintenance margins . An initial “margin,” meaning a cash deposit made at the ....
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