Currency Derivatives

1
Currency Derivatives

• Ways to limit exchange rate risk.

2
Introduction

• Currency futures contracts
• Currency options contracts
• Currency futures on options contracts

3
Currency Futures

• Currency forward contract is between two parties
  for delivery of
• Amount?
• When?
• Exchange rate?
• Currency futures contract is between two parties
  for delivery of
• Amount?
• When?
• Exchange rate?
• WSJ futures table/cme.com.

4
Performance Bond

• Initial performance bond
• Maintenance performance bond
• Marking to market
• Performance bond call
• Suppose you went short the March contract at
  yesterdays close of ?.
• Why would you do this?
• Then Day 1 up .0060 Day 2 up .0110 Day 3
  down .0220 Close position.

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Currency Options

• Forward and futures contracts immunize a firm
  against all changes in exchange rates.
• Currency Call Options
• Amount?
• When?
• Exchange rate?
• Currency Put Options
• WSJ tables/phlx.com

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Currency Options

• Buyer of Calls profits when?
• Buyer of Puts profits when?
• Who sells the option and how do they profit?
• Profit/loss graphs.

8
Option Value

• V intrinsic value time value
• Intrinsic value S X
• Time value V (S X)
• C ? Max(S X, 0)
• P ? Max(X S,0)

9
Option Value

• V f(S, X, T, rh, rf, ?S)
• S spot rate
• X Exercise price
• T time to expiration
• rh home interest rate
• rf foreign interest rate
• ?S standard deviation of changes in spot rate

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Uses for options and futures

• Example
• On July 1 an American firm sells goods to a Swiss
  firm for SF125,000 with payment due on September
  1. The American firm does not want francs and
  will exchange into dollars upon receipt.
  Currently,
• S .6922/SF

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Uses for options and futures

• The firms choices.
• Do nothing. What do they hope for?
• Forward contract at F .6850/SF
• Futures contract at F.6956/SF
• Options contract
• X Prem/SF Total Prem
• .68 .0059
• .70 .0144

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Uses for options and futures

• September 1
• S .6542/SF
• Futures .6558/SF
• 68 Put .0250/SF
• 70 Put .0447/SF

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Uses for options and futures

• September 1 alternative
• S .7338/SF
• Futures .7374/SF
• 68 Put .0010/SF
• 70 Put .0060/SF

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Conclusions

• Down Up E(value)
• Unhedged
• Forward
• Futures
• Out-of-
• In-
• If rates are expected to rise rapidly?
• If rates are expected to fall rapidly?

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Details

• Skip sections on option valuation.