International Finance_1_ by hcj

VIEWS: 5 PAGES: 18

									Foreign Currency Derivatives
          Markets
      International Financial
            Management
          Dr. A. DeMaskey



                                1
         Learning Objectives
￿ What  are currency futures and options
  contracts?
￿ What is the difference between spot, forward,
  futures and option types of foreign exchange
  financial instruments?
￿ How can currency futures and options be
  used to manage currency risk and to
  speculate on future currency movements?
￿ How is the value of currency options
  determined?                                     2
          Foreign Currency
             Derivatives
￿ Financial management in the 21st century
  needs to consider the use of financial
  derivatives
￿ These derivatives, so named because their
  values are derived from the underlying asset,
  are a powerful tool used for two distinct
  management objectives:
  – Speculation
  – Hedging
                                                  3
           Foreign Currency
              Derivatives
￿ Inthe wrong hands, derivatives can cause a
  corporation to collapse (Barings, Allied Irish
  Bank), but used wisely they allow a financial
  manager the ability to plan cash flows
￿ The financial manager must first understand
  the basics of the structure and pricing of
  these tools.
￿ The derivatives that will be discussed are:
   – Foreign Currency Futures
   – Foreign Currency Options
                                                   4
  Foreign Currency Futures

￿A  foreign currency futures contract is an
 alternative to a forward contract.
 – It calls for future delivery of a standard
   amount of currency at a fixed time and
   price.
 – These contracts are traded on exchanges
   with the largest being the International
   Monetary Market located in the Chicago
   Mercantile Exchange.
                                                5
     Contract Specifications

￿ Contract   size       ￿ Collateral   and
￿ Methodof stating       maintenance
 exchange rate           margin
￿ Maturity   dates      ￿ Settlement

￿ Last   trading date   ￿ Commission

                        ￿ Clearing

                         Operations          6
    Using Foreign Currency
           Futures
￿ Hedging

￿ Speculating

￿ Forward-Futures   Arbitrage




                                7
Profit or Loss from a Long
      Futures Hedge




                             8
Profit or Loss from a Short
       Futures Hedge




                              9
   Forward Contracts versus
      Futures Contracts
￿ Trading            ￿ Quotes
￿ Regulation         ￿ Transaction   costs
￿ Frequency    of    ￿ Collateral
  delivery           ￿ Credit risk
￿ Size of contract   ￿ Clearing Operation
￿ Delivery date        Location
￿ Settlement         ￿ Liquidity
￿ Pricing

                                             10
  Foreign Currency Options

￿A foreign currency option is a contract
 giving the option holder the right, but
 not the obligation, to buy or sell a given
 amount of foreign exchange at a fixed
 price per unit for a specified time period.
 – Call Option vs. Put Option
 – Holder vs. Grantor


                                               11
     Foreign Currency Options
           Terminology
￿   Every option has three       ￿   Options may also be
    different price elements         classified as per their
    – Strike or exercise price       payouts
    – Option premium                 – At-the-money
    – The underlying or actual       – In-the-money (ITM)
      spot rate in the market        – Out-of-the-money (OTM)
￿   There are two types of             options
    option maturities
    – American options
    – European options


                                                                12
           Market Structure
￿ Over-the-Counter    (OTC) Market
  – Main advantage is that they are tailored to
    purchaser
  – Counterparty risk exists
  – Mostly used by individuals and banks
￿ Organized   Exchanges
  – The Chicago Mercantile
  – Philadelphia Stock Exchange
  – Options Clearinghouse Corporation (OCC)

                                                  13
      Using Foreign Currency
             Options
￿ Users
  –   Financial Firms
  –   Corporations
￿ Hedging
￿ Speculating




                               14
Protecting Against the Potential
  Appreciation of a Currency
      Using a Call Option




                                   15
Protecting Against the Potential
  Depreciation of a Currency
      Using a Put Option




                                   16
          Option Pricing and
              Valuation
￿ An   option’s value consists of two parts:
  – Intrinsic Value
  – Time Value
￿ IntrinsicValue is the amount by which
  an option is in-the-money.
￿ Time Value is the amount by which an
  option’s value exceeds its intrinsic
  value.
                                               17
        Option Pricing Model

￿ The value of a currency option depends
 on the following five variables:
  – Strike price relative to the spot exchange
    rate
  – Time to maturity
  – Relative interest rates between the two
    currencies
  – Volatility of underlying currency
  – Supply and demand for specific option        18

								
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