Multinational Financial

Management
Alan Shapiro
7th Edition
J.Wiley & Sons
Power Points by
Joseph F. Greco, Ph.D.
California State University, Fullerton
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 CHAPTER 8

CURRENCY FUTURES
AND OPTIONS MARKETS
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CHAPTER OVERVIEW
I. FUTURES CONTRACTS
II. CURRENCY OPTIONS

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PART I.
FUTURES CONTRACTS
I.CURRENCY FUTURES
A. Background
1. 1972: Chicago Mercantile
Exchange
opens International Monetary
Market. (IMM)

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FUTURES CONTRACTS
2. IMM provides
a. an outlet for hedging currency
risk with futures contracts.
b. Definition of futures contracts:
contracts written requiring
• a standard quantity of an available currency
• at a fixed exchange rate
• at a set delivery date.

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FUTURES CONTRACTS
c. Available Futures Currencies:
1.) British pound 5.) Euro
2.) Canadian dollar 6.) Japanese yen
3.) Deutsche mark 7.) Australian dollar
4.) Swiss franc

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FUTURES CONTRACTS
d. Standard Contract Sizes:
contract sizes differ for each of
the 7 available currencies.

Examples:
Euro = 125,000
British Pound = 62,500
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FUTURES CONTRACTS
e. Transaction costs:
payment of commission to a
trader
f. Leverage is high
1.) Initial margin required is
relatively low (e.g. less than
.02% of sterling contract
value).
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FUTURES CONTRACTS
g. Maximum price movements
1.) Contracts set to a daily
price limit restricting
maximum daily price
movements.

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FUTURES CONTRACTS

2.) If limit is reached, a margin

call may be necessary to

maintain a minimum margin.

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FUTURES CONTRACTS
h. Global futures exchanges that
are competitors to the IMM:
1.) Deutsche Termin Bourse
2.) L.I.F.F.E.London International
Financial Futures Exchange
3.) C.B.O.T. Chicago Board of Trade

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FUTURES CONTRACTS
4.) S.I.M.E.X.Singapore International
Monetary Exchange
5.) H.K.F.E. Hong Kong Futures Exchange

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FUTURES CONTRACTS
B. Forward vs. Futures Contracts
Basic differences:
1. Trading Locations6. Settlement Date
2. Regulation 7. Quotes
3. Frequency of 8. Transaction
delivery costs
4. Size of contract 9. Margins
5. Delivery dates 10. Credit risk

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FUTURES CONTRACTS
Advantages of futures: Disadvantages of futures:
1.) Smaller 1.) Limited to 7
contract size currencies
2.) Easy liquidation 2.) Limited dates
3.) Well- organized of delivery
and stable 3.) Rigid contract
market. sizes.

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PART II
CURRENCY OPTIONS
I. OPTIONS
A. Currency options
1. offer another method to
hedge exchange rate risk.
2. first offered on Philadelphia
Exchange (PHLX).
3. fastest growing segment of
the hedge markets.
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CURRENCY OPTIONS
4. Definition:
a contract from a writer ( the seller) that
gives the right not the obligation to the
holder (the buyer) to buy or sell a standard
amount of an available currency at a fixed
exchange rate for a fixed time period.

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CURRENCY OPTIONS
5. Types of Currency Options:
a. American
exercise date may occur any
time up to the expiration date.
b. European
exercise date occurs only at the
expiration date.
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CURRENCY OPTIONS
7. Exercise Price
a. Sometimes known as the
strike price.
b. the exchange rate at
which the option holder
can buy or sell the
contracted currency.
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CURRENCY OPTIONS
8. Status of an option
a. In-the-money
Call: Spot > strike
Put: Spot < strike
b. Out-of-the-money
Call: Spot < strike
Put: Spot > strike
c. At-the-money
Spot = the strike
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CURRENCY OPTIONS
9. The premium: the price of an
option that the writer charges
the buyer.

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CURRENCY OPTIONS
B. When to Use Currency Options
1. For the firm hedging foreign
exchange risk

a. With sizable unrealized gains.

b. With foreign currency flows
forthcoming.

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CURRENCY OPTIONS
2. For speculators
- profit from favorable
exchange rate changes.

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CURRENCY OPTIONS
C. Option Pricing and Valuation
1. Value of an option equals
a. Intrinsic value
b. Time value

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CURRENCY OPTIONS
2. Intrinsic Value
the amount in-the-money

3. Time Value
the amount the option is in
excess of its intrinsic value.

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CURRENCY OPTIONS
4. Other factors affecting the
value of an option
a. value rises with longer
time to expiration.
b. value rises when greater
volatility in the exchange
rate.

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CURRENCY OPTIONS

5. Value is complicated by both

the home and foreign interest
rates.

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CURRENCY OPTIONS
D. Using Forward or Futures
Contracts:
Forward and futures contracts
are more suitable for hedging a
known amount of foreign
currency flow.

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CURRENCY OPTIONS
E. Market Structure
1. Location
a. Organized Exchanges
b. Over-the-counter
1.) Two levels
retail and wholesale
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