lecture4 - Lecture 4: Futures and Options Steven Skiena...

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Unformatted text preview: Lecture 4: Futures and Options Steven Skiena Department of Computer Science State University of New York Stony Brook, NY 117944400 http://www.cs.sunysb.edu/ skiena Foreign Currency Futures Assume that foreign country f has a risk-free interest rate in its own currency of r f . Let S be the spot price in dollars of one unit of f , and F be the future price in dollars of one unit of f . Then F = S e ( r- r f ) T Thus future currency prices are purely a function of the interest rates in the two countries! Pricing Currency Futures If one of these options is better, then I can borrow the initial money and guarantee a risk-free profit. Foreign Currency Arbitrage Note that I can borrow Y units of currency f at rate r f , (costing me Y e r f T in currency f then) convert this to dollars and invest (earning me Y S e rT in dollars then). Thus if F < S e ( r- r f ) T , I can go long on a forward contract to get the Y e r k T in currency f to pay them back at less than I earned on my dollars. Note that I can borrow Y dollars at rate r , (costing me Y e rT in dollars then), convert this to Y/S units of currency f , and invest this at rate r k (earning me ( Y/S ) e...
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This note was uploaded on 01/02/2012 for the course FINANCE 347 taught by Professor Bayou during the Fall '11 term at NYU.

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lecture4 - Lecture 4: Futures and Options Steven Skiena...

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