International Finance: Chapter 4
What is a Currency Future?
A currency future or an FX future is a future contract
between two parties to exchange one currency for another
at a fixed exchange rate on a fixed future date. Currency
futures are one of the main methods used to hedge against
exchange rate volatility, as they avoid the impact of currency
fluctuation over the period covered contract.
The investors use futures contracts to hedge against
foreign exchange risk. If an investor will receive a cashflow
denominated in a foreign currency on some future date, that
investor can lock in the current futures position that expires
on the date of the cashflow.
Currency futures can also be used to speculate and, by
incurring a risk, attempt to profit from rising or falling
exchange rates.
Currency Futures or FX Futures Introduction
• A currency future or an FX future is a future contract
between two parties to exchange one currency for
another at a fixed exchange rate on a fixed future date.
• Currency futures are traded via exchanges.
• They are based upon the exchange rate of a currency
pair and are settled in cash in the underlying currency.
• FX futures are one of the main methods used to hedge
against exchange rate volatility, as they avoid the impact
of currency fluctuation over the period covered by the
contract.
• Because currency futures contracts are marked to
market daily, investors can exit their obligation to buy
or sell the currency price to the contract’s delivery date.
• Future market participants and speculators usually close
out their positions before the date of settlement, so
most contracts do not tend to last until the date of
delivery.
• Currency future contracts are legally binding and
counterparties that are still holding the contracts on the
expiration date must trade the currency pair at a
specified price on the specified delivery date.
The Use of Currency Futures
• Investors use futures contracts to hedge against foreign
exchange risk.
• If an investor will receive a cashflow denominated in a
foreign currency on some future date, that investor can
lock in the current exchange rate by entering into an
offsetting currency futures position that expires on the
date of the cashflow.
• Currency futures can also be used to speculate and, by
incurring a risk, attempt to profit from rising or falling
exchange rates.
• Currency future contracts are usually sed by exporters
and importers to hedge their foreign currency payments
from exchange rates fluctuations.
What is the difference?
• Forward and future contracts are derivatives
arrangements that involve two parties who agree to buy
or sell a specific asset at a set price by a certain date in
the future. Buyers and sellers can mitigate the risks
associated with the price movements down the road by
locking in the purchase/sale price in advance.
• A forward contract is an arrangement made over-the-
counter (OTC) and settles just for once at the end of the
contract. It is privately negotiated and comes with a
degree of default risk since the counterparty is
responsible for remitting payment.
• Future contracts, on the other hand, are standardized
contracts that trade on stock exchanges. As such, they
are settled on a daily basis. These arrangements come
with fixed maturity dates and uniform terms. There is
very little risk with futures, as they guarantee on the
agreed-upon-date.
Future contracts are closed out or netted at their
expiration date. The price difference between the original
trade and the closing trade is cash-settled. Commodity
futures are typically used to take position in an underlying
asset. Typical assets include: crude oil, wheat, corn, gold,
silver, and natural gas.
International Finance: Chapter 5
The Balance of Payments
The price of a country’s currency depends on the
quantity supplied relative to the quantity demanded, at least
when exchange rates are determined in a free,
unregulated market. It follows that if we know the factors
influencing the supply of and demand for a currency, we also
know what factors influence exchange rates.
• Any factor increasing the demand for the currency will,
ceteris paribus, increase the foreign exchange value of
the currency, that is, cause the currency to appreciate.
• Similarly, any factor increasing the supply of the
currency will, ceteris paribus, reduce its foreign
exchange value, that is, cause the currency
to depreciate.
• Ceteris paribus is a Latin phrase that generally means
"all other things being equal.”
 Clearly then, there is considerable interest in
maintaining a record of the factors affecting the supply of
and demand for a country’s currency. That record is
maintained in the balance-of-payments account. Indeed, we
can think of the balance-of-payments account as an
itemization of the reasons for demand for and supply of a
currency.
The balance of payments summarizes the economic
transactions of an economy with the rest of the world. These
transactions include exports and imports of goods, services
and financial assets, along with transfer payments (like
foreign aid). The balance of payments is an important
economic indicator for ‘open’ economies like Australia that
engage in international trade because it summarizes how
resources flow between Australia and our trading partners.
International Finance: Chapter 7
Supply-and-Demand View of Exchange Rates
In this chapter we consider these forces of supply and
demand by deriving the supply and demand curves for a
currency and using them to explain what makes exchange
rates change. As we might expect, this involves
consideration of the effects of items listed in the balance-of-
payments account on the supply and demand curves. With
the balance-of-payments account recording flows of
payments into and out of a country, the explanation of
exchange rates based on the account emphasizes flow
demands and supplies of a currency. However, as we shall
see, in the case of currencies there is no assurance that the
supply-and-demand situation will have the form that is
familiar from the applications of supply and demand in other
markets.

International Finance: Chapter 6, Portfolio Investment

What is a high-risk, high-return investment? What is Purchasing Power Parity?

High-risk investments may offer the chance of higher • A theoretical exchange rate that allows you to buy the
returns than other investments might produce, but they put same amount of goods and services in every country.
your money at higher risk.
• Government agencies use it to compare the output of
countries that use different exchange rates.
What is an International Portfolio?
• Example: If you want to live cheap, and you can move to
An international portfolio is a selection of stocks and
any country in the world, compare prices of a Big Mac.
other assets that focuses on foreign markets rather than
domestic ones. If well designed, an international portfolio
gives the investor exposure to emerging and developed
markets and provides diversification.

International Portfolio’s:

Advantages Disadvantages
• Market cycle timing • Political and economic risk

• May reduce risk • Increased transaction cost

• Diversity currency exposure • Currency exchange rate risk

How do I make an International Portfolio?

International portfolios give you more diversification, let

you access liquidity in other markets, and can help you
reduce the risks of the market you invest in the most.

The Benefits of International Portfolio Investment

Most retail investors should talk to a professional

financial advisor about international investing. Many
brokerages have funds that can give you the necessary
exposure to international markets.

How do I invest internationally?

To invest internationally, you can choose mutual

funds, American depository receipts (ADRs), or invest
directly in a foreign market.