ch07 - Chapter 7 Currency Futures and Options Markets...

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Chapter 7 Currency Futures and Options Markets
Chapter 7: Currency Futures and Options Markets 2 Chapter 7 Outline A. Forward and Futures Contracts B. Currency Options C. Forward and Futures Contracts versus Currency Options D. Futures Options E. Reading Currency Futures and Options Prices
Chapter 7: Currency Futures and Options Markets 3 7.A Futures and Forward Contracts (1) Futures contracts Contracts to buy or sell standardized quantities of given currencies, with standardized delivery dates, trading on organized exchanges Chicago Mercantile Exchange (CME) – the exchange on which most currency futures are traded
Chapter 7: Currency Futures and Options Markets 4 7.A Futures and Forward Contracts (2) Futures contracts, continued Margin requirements Initial performance bond (formerly initial margin) – a minimum account balance required to enter into a contract Maintenance performance bond (formerly maintenance margin) – the balance below which a performance bond call is triggered Performance bond call (formerly margin call) – a requirement to add funds when the account balance falls below the maintenance performance bond level to bring the balance in line with the initial performance bond level Daily settlement 1. Unrealized profits and losses on a contract resulting from price movements are marked to market (paid daily) 2. The existing contract reflecting the currency’s old price is canceled 3. A new contract reflecting the prevailing price is issued
Chapter 7: Currency Futures and Options Markets 5 7.A Futures and Forward Contracts (3) Futures contracts, continued E.g.: Short one CME yen futures contract for ¥12.5 million with initial performance bond of $4,590 and maintenance performance bond of $3,400. Trading Day Currency Price Action Credit/Debit Account Balance 1 (open) $0.008233 Initial performance bond $4,590.00 $4,590.00 1 (close) $0.008342 Daily loss marked to market -$1,362.50 $3,227.50 Performance bond call deposit $1,362.50 $4,590.00 2 (close) $0.008381 Daily loss marked to market -$487.50 $4,102.50 3 (close) $0.008175 Daily gain marked to market $2,575.00 $6,677.50 4 (close) $0.008169 Daily gain marked to market $75.00 $6,752.50 5 (close) $0.008194 Daily loss marked to market -$312.50 $6,440.00 Round-trip commission to close account -$27.00 $6,413.00
Chapter 7: Currency Futures and Options Markets 6 7.A Futures and Forward Contracts (4) Arbitrage using forward and futures contracts Dealers seek to profit from differences in forward and futures bid prices for a currency. E.g., Forward bid on £ 62,500 pounds sterling = $1.9727; futures price = $1.9715. Buy futures contract for $123,218.75 (62,500 * $1.9715) Simultaneously sell an equivalent amount of sterling forward (62,500 * $1.9727) for $123,293.75 Profit = $75 Arbitrage transactions will bid up the futures price and bid down the forward price until price equilibrium is restored.
Chapter 7: Currency Futures and Options Markets 7 7.B Currency Options (1) An option is a financial instrument that gives the holder the right but not the obligation to sell (put) or buy (call) another financial instrument at a set (strike or exercise) price and expiration date. Options can be exercised or sold. Exercising an option

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