Security deposit compensating bank balances or credit

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Security deposit Compensating bank balances or credit lines needed Small security deposit required Clearing operation Handled by individual banks and brokers Handled by exchange clearinghouse. Daily settlements. Marketplace Worldwide Central exchange Regulation Self-regulating. Commodity Futures Trading Commission (CFTC) and National Futures Association Liquidation Mostly settled by actual delivery Mostly settled by offsetting transactions Transaction Costs Bank’s bid/ask spread Negotiated brokerage fees
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Foreign Currency Options A foreign currency option is a contract giving the purchaser of the option the right to buy or sell a given amount of currency at a fixed price per unit for a specified time period The most important part of clause is the “right, but not the obligation” to take an action Two basic types of options, calls and puts Call – buyer has right to purchase currency Put – buyer has right to sell currency The buyer of the option is the holder and the seller of the option is termed the writer
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Foreign Currency Options Every option has three different price elements The strike or exercise price is the exchange rate at which the foreign currency can be purchased or sold The premium , the cost, price or value of the option itself paid at time option is purchased Spot exchange rate in the market There are two types of option maturities American options may be exercised at any time during the life of the option European options may not be exercised until the specified maturity date
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Foreign Currency Options Options may also be classified as per their payouts At-the-money (ATM) options have an exercise price equal to the spot rate of the underlying currency In-the-money (ITM) options may be profitable, excluding premium costs, if exercised immediately Out-of-the-money (OTM) options would not be profitable, excluding the premium costs, if exercised
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Foreign Currency Options Markets Over-the-Counter (OTC) Market – OTC options are most frequently written by banks for US dollars against British pounds, Swiss francs, Japanese yen, Canadian dollars and the euro Main advantage is that they are tailored to purchaser Counterparty risk exists Mostly used by individuals and banks Organized Exchanges – similar to the futures market, currency options are traded on an organized exchange floor The Chicago Mercantile and the Philadelphia Stock Exchange serve options markets Clearinghouse services are provided by the Options Clearinghouse Corporation (OCC)
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Tri dent’s Transaction Exposure CFO of Trident, has just concluded a sale to Regency, a British firm, for £1,000,000 The sale is made in March for settlement due in June (3 months) Assumptions Spot rate is $1.7640/£ 3-month forward rate is $1.7540/£ (a 2.27% discount) Trident’s cost of capital is 12.0%
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  • Fall '19
  • Trident

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