Chapter 7 Furtures and options of foreign exchange.pptx -...

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Master Your Career Growth Chapter 7 Futures and options on foreign exchange
Futures Contracts: Preliminaries A futures contract is like a forward contract in that it specifies that a certain currency will be exchanged for another at a specified time in the future at prices specified today. A futures contract is different from a forward contract in that futures are standardized contracts trading on organized exchanges with daily resettlement through a clearinghouse. Standardized features: Contract size Delivery month Daily resettlement (mark to market)
Contract size standards Currency Contract Size Australian dollar AUD 100,000 British pound GBP 62,500 Canadian dollar CAD 100,000 Euro EUR 125,000 Japanese yen JPY 12,500,000 New Zealand dollar NZD 100,000 Swiss franc CHF 125,000
Daily Resettlement: An Example With futures contracts, we have daily resettlement of gains and losses rather than one big settlement at maturity. Every trading day: If the price goes down, the long pays the short. If the price goes up, the short pays the long. After the daily resettlement, each party has a new contract at the new price with one-day-shorter maturity. Each day’s losses are subtracted from the investor’s account. Each day’s gains are added to the account.
Daily Resettlement: An Example Consider a long position in the CME Euro/U.S. Dollar contract. It is written on €125,000 (one futures contract) and quoted in $ per € ($/€). The strike price is $1.30 per € the maturity is 3 months. At initiation of the contract, the long position requires an initial deposit of $6,500. The maintenance deposit is $4,000.
Daily Resettlement: An Example Over the next 2 days, the long keeps losing money and closes out his position at the end of day five. $1,250 –$1,250 $1.31 $1.30 $1.27 $1.26 $1.24 –$3,750 –$1,250 –$2,500 Gain/Loss Settle $7,750 $6,500 $2,750 + $3,750 = $6,500 $2,750 Account Balance = $6,500 – $1,250 $5,250
Toting Up At the end of his adventure, our investor has three ways of computing his gains and losses: 1. Sum of daily gains and losses. – $7,500 = $1,250 – $1,250 – $3,750 – $1,250 – $2,500 2. Contract size times the difference between initial contract price and last settlement price. – $7,500 = ($1.24/€ – $1.30/€) × €125,000 3. Ending balance on the account minus beginning balance on the account, adjusted for deposits or withdrawals. – $7,500 = $2,750 – ($6,500 + $3,750)
Currency Futures Markets The CME Group (formerly Chicago Mercantile Exchange) is by far the largest currency futures market.

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