Professional Documents
Culture Documents
11th Edition
by Jeff Madura
1 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
5 Currency Derivatives
Chapter Objectives
Definition
• A currency derivative is a contract whose price is
derived from the value of an underlying currency.
Functions
• Speculate on future exchange rate movements
• Hedge exposure to exchange rate risk
Example
• Forwards/futures contracts
• Options contracts
3 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Forward Market
• Hedge their imports by locking in the rate at which they can obtain
the currency
1
5 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Premium or Discount on the Forward Rate
F = S(1 + p)
where:
F is the forward rate
S is the spot rate
p is the forward premium, or the percentage by
which the forward rate exceeds the spot rate.
6 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5.1 Computation of Forward Rate Premiums or
Discounts
7 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Premium or Discount on the Forward Rate
Arbitrage – If the forward rate was the same as the spot rate,
arbitrage would be possible.
Movements in the Forward Rate over Time – The forward
premium is influenced by the interest rate differential
between the two countries and can change over time.
Offsetting a Forward Contract – An MNC can offset a
forward contract by negotiating with the original counterparty
bank.
Non-deliverable forward contracts (NDF) can be used for
emerging market currencies where no currency delivery takes
place at settlement; instead one party makes a payment to the
other party.
8 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Currency Futures Market
9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5.2 Currency Futures Contracts Traded on the
Chicago Mercantile Exchange
10 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Trading Currency Futures
11 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5.3 Comparison of the Forward and Futures Market
13 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
How Firms Use Currency Futures
14 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Closing Out a Futures Position
15 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5.4 Closing Out a Futures Contract
16 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Speculation with Currency Futures
17 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5.5 Source of Gains from Buying Currency
Futures
18 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Currency Futures Market Efficiency
19 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Currency Options Markets
21 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Factors Affecting Currency Call Option Premiums
22 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
How Firms Use Currency Call Options
23 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Currency Put Options
24 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Factors Affecting Put Option Premiums
25 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Hedging with Currency Put Options
26 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Speculating with Currency Put Options
27 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5.6 Contingency Graphs for Currency Options
28 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Conditional Currency Options
29 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 5.7 Comparison of Conditional and Basic
Currency Options
30 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
European Currency Options
31 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
SUMMARY
32 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
SUMMARY (Cont.)
33 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
arbitrage action to capitalize on a discrepancy in quoted prices; in many cases, there
is no investment of funds tied up for any length of time.
contingency graph graph showing the net profit to a speculator in currency options under
various exchange rate scenarios.
currency call option contract that grants the right to purchase a specific currency at a specific
price (exchange rate) within a specific period of time.
currency futures contract specifying a standard volume of a particular currency to be
contracts exchanged on a specific settlement date.
currency option the use of simultaneous call and put option positions to construct a unique
combination position to suit the hedger’s or speculator’s needs. Two of the most popular
currency option combinations are straddles and strangles.
currency put option contract granting the right to sell a particular currency at a specified price
(exchange rate) within a specified period of time.
exercise price price (exchange rate) at which the owner of a currency call option is
(strike price) allowed to buy a specified currency; or the price (exchange rate) at which
the owner of a currency put option is allowed to sell a specified currency.
34 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
forward contract agreement between a commercial bank and a client about an
exchange of two currencies to be made at a future point in time at a
specified exchange rate.
forward rate rate at which a bank is willing to exchange one currency for another
at some specified date in the future.
non-deliverable like a forward contract, represents an agreement regarding a position
forward contract in a specified currency, a specified exchange rate, and a specified
(NDF) future settlement date, but does not result in delivery of currencies.
Instead, a payment is made by one party in the agreement to the
other party based on the exchange rate at the future date.
straddle combination of a put option and a call option.
straddles combination of a put option and a call option.
strangles a currency option combination; similar to a straddle.
strike price See exercise price.
writer seller of an option.
35 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.