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Foundations of Multinational Financial Management 5 th Edition Alan Shapiro J. Wiley & Sons Foundations of Multinational Financial Management 5 th Edition Alan Shapiro J. Wiley & Sons Power Points by Joseph F. Greco, Ph. D. California State University, Fullerton

Currency Futures and Options Markets Chapter 8 Currency Futures and Options Markets Chapter 8

PART I. FUTURES CONTRACTS I. CURRENCY FUTURES A. Background 1. Long history 2. Extremely PART I. FUTURES CONTRACTS I. CURRENCY FUTURES A. Background 1. Long history 2. Extremely volatile due to information driven nature 3. Price Discovery Role Financial derivatives: they are contracts that derive their value from some underlying asset(stock , bond, currency) 1. Forwards 2. Futures 3. Options 4. SWAP 3

FUTURES CONTRACTS 1972: Chicago Mercantile Exchange(CME芝 加哥商品交易所) opens the International Monetary Market (IMM). Purpose: FUTURES CONTRACTS 1972: Chicago Mercantile Exchange(CME芝 加哥商品交易所) opens the International Monetary Market (IMM). Purpose: speculator vs hedger 4

FUTURES CONTRACTS 2. IMM provides a. an outlet for hedging currency risk with futures FUTURES CONTRACTS 2. IMM provides a. an outlet for hedging currency risk with futures contracts. Definition: contracts written requiring a standard quantity of an available currency at a fixed exchange rate at a set delivery date. 5

FUTURES CONTRACTS b. Available Futures Currencies/Contract Size: 1. ) British pound / 62, 500 FUTURES CONTRACTS b. Available Futures Currencies/Contract Size: 1. ) British pound / 62, 500 2. ) 3. ) 4. ) 5. ) 6. ) 7. ) Canadian dollar /100, 000 Euro / 125, 000 Swiss franc / 125, 000 Japanese yen / 12. 5 million Mexican peso / 500, 000 Australian dollar / 100, 000 6

FUTURES CONTRACTS c. Transaction costs: commission payment to a floor trader d. Leverage is FUTURES CONTRACTS c. Transaction costs: commission payment to a floor trader d. Leverage is high 1. ) Initial margin required is relatively low (less than 2% of contract value). 7

FUTURES CONTRACTS: SAFEGUARDS e. Maximum price movements 1. ) Contracts set to a daily FUTURES CONTRACTS: SAFEGUARDS e. Maximum price movements 1. ) Contracts set to a daily price limit restricting maximum daily price movements. 2. ) If limit is reached, a margin call may be necessary to maintain a minimum margin保證金. Initial Margin: 當期貨交易開始時需具備的金額 Maintenance Margin: 當低於維持保證金時,必 須補足金額至原始保證金的額度 8

FUTURES CONTRACTS g. Global futures exchanges: 1. ) 2. ) 3. ) 4. ) FUTURES CONTRACTS g. Global futures exchanges: 1. ) 2. ) 3. ) 4. ) 5. ) 6. ) I. M. M. International Monetary Market L. I. F. F. E. London International Financial Futures Exchange C. B. O. T. Chicago Board of Trade S. I. M. E. X. Singapore International Monetary Exchange D. T. B. Deutsche Termin Bourse H. K. F. E. Hong Kong Futures Exchange 平倉(offsetting trade): 一買一賣抵銷交易,不用到期交 割 9

FUTURES CONTRACTS B. Forward vs. Futures Contracts Basic differences: 1. Trading Locations 2. Regulation FUTURES CONTRACTS B. Forward vs. Futures Contracts Basic differences: 1. Trading Locations 2. Regulation 3. Frequency of delivery 4. Size of contract 5. Transaction Costs 6. Quotes 7. Margins 8. Credit risk 10

FUTURES CONTRACTS Advantages of futures: 1. ) Easy liquidation 2. ) Well- organized and FUTURES CONTRACTS Advantages of futures: 1. ) Easy liquidation 2. ) Well- organized and stable market. Disadvantages of futures: 1. ) Limited to 7 currencies 2. ) Limited dates of delivery 3. ) Rigid contract sizes. 11

CURRENCY OPTIONS PART II CURRENCY OPTIONS PART II

CURRENCY OPTIONS I. OPTIONS A. Currency options 1. Offer another method to hedge exchange CURRENCY 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. 13

CURRENCY OPTIONS Buyers Sellers=Writers Premium Buy Sell PUT CALL 14 CURRENCY OPTIONS Buyers Sellers=Writers Premium Buy Sell PUT CALL 14

CURRENCY OPTIONS 4. Definition: A contract from a writer ( the seller) that gives 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. 15

CURRENCY OPTIONS 5. Expiration Dates of Currency Options: a. American Exercise date may occur CURRENCY OPTIONS 5. Expiration Dates 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 and not before. 16

CURRENCY OPTIONS 7. Exercise Price a. b. Sometimes known as the strike price. The CURRENCY OPTIONS 7. Exercise Price a. b. Sometimes known as the strike price. The exchange rate at which the option holder can buy or sell the contracted currency. 17

CURRENCY OPTIONS c. Types of Currency Options: 1. ) Calls 2. ) Puts 18 CURRENCY OPTIONS c. Types of Currency Options: 1. ) Calls 2. ) Puts 18

CURRENCY OPTIONS 8. Status of an option a. In-the-money Call: Spot > strike Put: CURRENCY OPTIONS 8. Status of an option a. In-the-money Call: Spot > strike Put: Spot < strike b. Out-of-the-money Call: Spot < strike Put: Spot > strike c. At-the-money Spot = the strike 19

CURRENCY OPTIONS 9. What is the premium? - The price of an option that CURRENCY OPTIONS 9. What is the premium? - The price of an option that the writer charges the buyer. B. Why Use Currency Options? 1. For the firm hedging foreign exchange risk with Future event is very uncertain gains. 20

CURRENCY OPTIONS 2. For speculators - profit from favorable exchange rate changes. 21 CURRENCY OPTIONS 2. For speculators - profit from favorable exchange rate changes. 21

CURRENCY OPTIONS C. Using Forward or Futures Contracts Forward or futures contracts are more CURRENCY OPTIONS C. Using Forward or Futures Contracts Forward or futures contracts are more suitable for hedging a known amount of foreign currency flow. 22

Options Sample Problems Ford buys a French put option (contract size: FF 250, 000) Options Sample Problems Ford buys a French put option (contract size: FF 250, 000) at a premium of $. 01/FF. If the exercise price is $. 21 and the spot at expiration is $. 216, what is Ford’s profit (loss)? 23