Futures and Options on Foreign Exchange - Towson ….ppt

Chapter Objective:
This chapter discusses exchange-traded currency futures contracts, options contracts, and options on currency futures.
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Chapter Seven
Futures and Options on Foreign Exchange
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Primary vs. Derivative Products
Primary Financial Products: their values are determined by their own cash flows. ., stocks, bonds, currencies, (real & artificial) commodities, etc
Derivative Products (Derivatives, Contingent Claims): their values are derived from the value of the underlying primary security. ., forward, futures, options, swaps, insurance products, etc.
Futures Contracts: Preliminaries
A futures contract is like a forward contract:
It specifies that a certain currency will be exchanged for another at a specified time in the future at prices specified today.
A futures contract is different from a forward contract:
Futures are standardized contracts trading anized exchanges with daily resettlement through a clearinghouse.
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Futures Contracts: Preliminaries
Standardizing Features:
CFTC
Contract size ~ originally determined around $100k
Delivery months ~ 3, 6, 9, 12
Daily settlement (mark to market)
Trading costs ~ Commission
A daily price limit
Initial performance bond (=initial margin, about 2 percent of contract value, cash or T-bills held in a street name at your brokerage).
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Daily Settlement: An Example
Consider a long position in the CME Euro/. Dollar contract.
It is written on €125,000 and quoted in $ per €.
The strike price is $ the maturity is 3 months.
At initiation of the contract, the long posts an initial performance bond of $6,500.
The maintenance performance bond is $4,000.
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Daily Settlement: An Example
Recall that an investor with a long position gains from increases in the price of the underlying asset.
Our investor has agreed to BUY €125,000 at $ per euro in three months time.
With a forward contract, at the end of three months, if the euro was worth $, he would lose $7,500 = ($ –$) × 125