Multinational Financial Management Alan Shapiro 7th Edition J.Wiley

1
Multinational Financial Management Alan Shapiro
7th EditionJ.Wiley Sons

• Power Points by
• Joseph F. Greco, Ph.D.
• California State University, Fullerton

2
CHAPTER 8

• CURRENCY FUTURES AND OPTIONS MARKETS

3
CHAPTER OVERVIEW

• I. FUTURES CONTRACTS
• II. CURRENCY OPTIONS

4
PART I.FUTURES CONTRACTS

• I. CURRENCY FUTURES
• A. Background
• 1. 1972 Chicago Mercantile
• Exchange
• opens International Monetary Market. (IMM)

5
FUTURES CONTRACTS

• 2. IMM provides
• a. an outlet for hedging currency risk with
  futures contracts.
• b. Definition of futures contracts
• contracts written requiring
• a standard quantity of an available currency
• at a fixed exchange rate
• at a set delivery date.

6
FUTURES CONTRACTS

• c. Available Futures Currencies
• 1.) British pound 5.) Euro
• 2.) Canadian dollar 6.) Japanese yen
• 3.) Deutsche mark 7.) Australian dollar
• 4.) Swiss franc

7
FUTURES CONTRACTS

• d. Standard Contract Sizes
• contract sizes differ for each of
• the 7 available currencies.
• Examples
• Euro 125,000
• British Pound 62,500

8
FUTURES CONTRACTS

• e. Transaction costs
• payment of commission to a trader
• f. Leverage is high
• 1.) Initial margin required is
• relatively low (e.g. less than .02 of
  sterling contract value).

9
FUTURES CONTRACTS

• g. Maximum price movements
• 1.) Contracts set to a daily price limit
  restricting maximum daily price
  movements.

10
FUTURES CONTRACTS

• 2.) If limit is reached, a margin
• call may be necessary to maintain a minimum
  margin.

11
FUTURES CONTRACTS

• h. Global futures exchanges that are competitors
  to the IMM
• 1.) Deutsche Termin Bourse
• 2.) L.I.F.F.E.London International Financial
  Futures Exchange
• 3.) C.B.O.T. Chicago Board of Trade

12
FUTURES CONTRACTS

• 4.) S.I.M.E.X.Singapore International
• Monetary Exchange
• 5.) H.K.F.E. Hong Kong Futures Exchange

13
FUTURES CONTRACTS

• B. Forward vs. Futures Contracts
• Basic differences
• 1. Trading Locations 6. Settlement
  Date
• 2. Regulation 7. Quotes
• 3. Frequency of 8. Transaction
• delivery costs
• 4. Size of contract 9. Margins
• 5. Delivery dates 10. Credit risk

14
FUTURES CONTRACTS

• Advantages of futures
• 1.) Smaller
• contract size
• 2.) Easy liquidation
• 3.) Well- organized
• and stable market.

• Disadvantages of futures
• 1.) Limited to 7
• currencies
• 2.) Limited dates
• of delivery
• 3.) Rigid contract
• sizes.

15
PART IICURRENCY OPTIONS

• I. OPTIONS
• A. Currency options
• 1. offer another method to hedge exchange
  rate risk.
• 2. first offered on Philadelphia
• Exchange (PHLX).
• 3. fastest growing segment of
• the hedge markets.

16
CURRENCY OPTIONS

• 4. Definition
• a contract from a writer ( the seller) that
  gives the right not the obligation to the
  holder (the buyer) to buy or sell a standard
  amount of an available currency at a fixed
  exchange rate for a fixed time period.

17
CURRENCY OPTIONS

• 5. Types of Currency Options
• a. American
• exercise date may occur any
• time up to the expiration date.
• b. European
• exercise date occurs only at the
• expiration date.

18
CURRENCY OPTIONS

• 7. Exercise Price
• a. Sometimes known as the
• strike price.
• b. the exchange rate at which the option
  holder can buy or sell the contracted
  currency.

19
CURRENCY OPTIONS

• 8. Status of an option
• a. In-the-money
• Call Spot gt strike
• Put Spot lt strike
• b. Out-of-the-money
• Call Spot lt strike
• Put Spot gt strike
• c. At-the-money
• Spot the strike

20
CURRENCY OPTIONS

• 9. The premium the price of an
• option that the writer charges the buyer.

21
CURRENCY OPTIONS

• B. When to Use Currency Options
• 1. For the firm hedging foreign
• exchange risk
• a. With sizable unrealized gains.
• b. With foreign currency flows
  forthcoming.

22
CURRENCY OPTIONS

• 2. For speculators
• - profit from favorable exchange rate
  changes.

23
CURRENCY OPTIONS

• C. Option Pricing and Valuation
• 1. Value of an option equals
• a. Intrinsic value
• b. Time value

24
CURRENCY OPTIONS

• 2. Intrinsic Value
• the amount in-the-money
• 3. Time Value
• the amount the option is in
• excess of its intrinsic value.

25
CURRENCY OPTIONS

• 4. Other factors affecting the
• value of an option
• a. value rises with longer
• time to expiration.
• b. value rises when greater volatility in
  the exchange rate.

26
CURRENCY OPTIONS

• 5. Value is complicated by both
• the home and foreign interest
• rates.

27
CURRENCY OPTIONS

• D. Using Forward or Futures Contracts
• Forward and futures contracts are more
  suitable for hedging a known amount of foreign
  currency flow.

28
CURRENCY OPTIONS

• E. Market Structure
• 1. Location
• a. Organized Exchanges
• b. Over-the-counter
• 1.) Two levels
• retail and wholesale