CHAPTER

EIGHT

FOREIGN CURRENCY
FUTURES MARKET

1
 CHAPTER OVERVIEW

• Introduction
• Contract specifications
• Futures contract daily settlement
• Hedging by Futures contract
• Speculation using Futures contract

2
 FOREIGN CURRENCY FUTURES
• A foreign currency futures contract is an agreement for
future delivery of an amount of foreign exchange at a fixed
time, place, and price
– Foreign currency futures are standard contracts traded on an
exchange, but foreign exchange forward (FX forward) contracts are
contracts traded in the over-the-counter market
– The other differences between foreign currency futures and FX
forward contracts are compared on Slide 12.
• It is similar to futures contracts that exist for other
underlying assets, like gold, cattle, Treasury bonds, etc.
• The most important market in the world for foreign
currency futures is the CME group
– CME Group was created on July 12, 2007 from the merger between
the Chicago Mercantile Exchange (CME) and the Chicago Board of
Trade (CBOT)
 FUTURES CONTRACT

– Many other exchanges throughout the world trade

futures contracts: LIFFE, SOFFEX, TIFFE,
SIMEX...
– There are many kind of futures contracts:
– Commodity futures contract,
– Foreign currency futures contract,
– LIBOR futures contract,
– T-Bill futures contract and
– Futures contract on S&P’s 500 Stock Index…
 FUTURES CONTRACT #

• Contracts of exchange-traded derivatives are standard

contracts established by the exchange on which the
derivatives are traded
• Major features of the foreign currency futures that are
standardized are as follows
– Contract size (also called the notional principal)
– Method of stating exchange rates (“American terms” are used, i.e., the
US$ price of one foreign currency)
– Maturity date (matured on the third Wednesday of Jan., Mar., Apr.,
Jun., Jul., Sept., Oct., and Dec.)
– Last trading day (the second business day prior to the maturity date)
– Commissions (Customers pay a commission to their broker for a round
transaction, which differs from that in the interbank market, dealers
earn the bid and ask spread and do not charge a commission)
 FUTURES CONTRACT
– Settlement
• Only 5% of all futures contracts are settled by the physical delivery of foreign
exchange between buyer and seller
• Most often, buyers and sellers offset their original positions prior to the
delivery date by taking an opposite position
– Collateral and margins
• To prevent the default risk, both sellers and buyers must deposit a sum as the
initial margin, which is a kind of cash collateral
• The value of the contract is marked to market and all changes in value are
paid from the margin account daily
• Marked to market means that the value of the contract is revalued using the
closing price for the day
• If the balance of the margin account falls below the maintenance margin, the
investor receives a margin call and needs to top up the margin account to the
initial margin level the next day
– Use of a clearing house as a counterparty (all contracts can be viewed as
agreements between an investor and the exchange clearing house, rather
than between two investors involved)
 FUTURES CONTRACT

– The contract size specifies the amount of the asset that has to be
delivered under one contract. Contract size for a contract vary from
commodity to financial future.
– The price agreed to by the two traders on the floor of exchange is
known as the futures price. This price, like any other price, is
determined by the laws of supply and demand.
– A futures contract is refereed to by its delivery month. The exchange
must specify the precise period during the month when delivery can be
made. The delivery months vary from contract to contract.
– Traders charge commissions on futures contracts rather than using the
bid-ask spreads found in the forward market.
– Futures contract can be closed out with an offsetting trade.
– Profits and losses of futures contract are paid every day at the end of
trading, it called marking to market
 FUTURES CONTRACT #
– Performance bond (Margin) requirement reduces risk for investor’ s future. The
initial margin shows how much money must be in the amount balance when the
contract is entered into.
– A Performance bond (margin) call is issued if the balance in the account falls
below the maintenance margin that new money must be added to the account
balance to bring it up to the maintenance margin.
– Daily settlement reduces default risk of futures contract relative to forward
contracts
– Everyday, futures investors must pay over any losses or receive any gains from
the day’s price movements. These gains or losses are generally added to or
subtracted from the investor’s margin account.
 EXHIBIT 7.1 CONTRACT SPECIFICATIONS FOR FOREIGN CURRENCY FUTURES

AUSTRALIA BRITISH CANADIAN JAPANESE EURO MEXICAN SWISS

N DOLLAR POUND DOLLAR YEN FX PESO FRANC

CONTRACT SIZE A$ 100,000 £62,500 C$ 100,000 ¥12,500,000 €125,000 P500,000 SFr 125,000

SYMBOL AD BP CD JY EC MP SF

PERFORMANCE BOND
REQUIREMENTS

INITIAL $2,013 $1,320 $1,265 $3,850 $2,475 $2,035 $2,200

MAINTENANCE $1,830 $1,200 $1,150 $3,500 $2,250 $1,850 $2,000

MINIMUM PRICE $0.0001 $0.0002 $0.0001 $0.000001 $0.0001 $0.000025 0.0001

CHANGE
(1pt.) (2pts.) (1pt.) (1pt.) (1pt.) (1pt.)

VALUE OF 1 POINT $10.00 $6.25 $10.00 $12.50 $12.50 $12.50 $12.50

MONTHS TRADED March, June, September, December

TRADING HOURS 7:20AM – 2:00PM (central time)

LAST DAY OF The second business day immediately preceding the third Wednesday of the delivery month
TRADING

Source: Chicago Mercantile Exchange, contract highlight, July 2013

Table 7.3 FOREIGN EXCHANGE FUTURE QUOTES FROM THE WALL STREET
Table 7.3 FOREIGN EXCHANGE FUTURE QUOTES FROM THE WALL STREET
 AN EXAMPLE OF DAILY SETTLEMENT WITH A
FUTURES CONTRACT #
Time Action Cash flow
Tuesday Investor buys SFr futures none
morning contract that matures in two
days. Price is $0.75
Tuesday close Futures price rises to $0.755. Investor receives
Position is marked to market 125,000 x(0.755-0.75) = $625

Wednesday Futures price drops to $0.743. Investor pays

close Position is marked to market 125,000 x(0.755-0.743) = $1.500

Thursday close Futures price drops to $0.74. (1) Investor pay

(1) Contract is marked to market
(2) Investor takes delivery on SFr
125,000
125,000 x (0.743-0.74) = $375
(2) Investor pays
125,000 x 0.74 = $95,500
Net loss on the futures contract =
$1,250
 exercise

This morning, you entered into a future contract to buy €62,500 at $1.50 per €.
Suppose the expected futures price closes at Nov 07, 08, 09: $1.48; $1.50; $1.52

1. Initial margin: 1500$

2. Maintenance margin: 1300$
3. How much have you made/lost in total?
4. Daily profit?
5. Margins Call?

13
EXHIBIT 1 COMPARISONS BETWEEN CURRENCY
FUTURES AND FORWARDS
 HEDGING USING FUTURES

• Example, In Dec 2014, Company A, based in the US, knows that it will
have to pay £1 millions in Jan. 2015. for goods it has purchased from a
British supplier. The current exchange rate is $1.8220, and Jan. futures
price for CME contracts on £ is $1.8250
• Solution:
– Company A could hedge its foreign exchange risk by taking a long position
in £1 million worth of Jan. futures contracts. Total of 16 contracts would
have to be purchased.
• Example, Company B, based in the US, export goods to UK and in
Dec. 2014 knows that it will receive £3 millions in May 2015. The
current exchange rate is $1.8220, and May futures price for CME
contracts on £ is $1.8350
• Solution:
– Company B could hedge its foreign exchange risk by taking a short position
in £3 million worth of May futures contracts. Total of 48 contracts would
have to be purchased.
 SPECULATION USING FUTURES

• In February, US speculator think that £will appreciate to the US dollar over the
next two months and is prepared to back that hunch to the tune of £250,000.
• Solution:
– One thing the speculator can do is simply purchase £250,000 hope that the sterling
can be sold later at a profit.
– Another possibility is to take a long position in four April futures contracts on sterling
• Outcome:
– Exchange rate is 1.7000 in two months. The investor makes $13.250 using the first
strategy and $14,750 using the second strategy
– Exchange rate is 1.6000 in two months. The investor has a loss of $11.750 using the
first strategy and $10,250 using the second strategy