FX Derivatives.ppt

FX Derivatives
1. FX Futures and Forwards
FX RISK
Example: ABYZ, a . company, imports wine from France. ABYZ has to pay EUR 5,000,000 on May 2. Today, February 2, the exchange rate is USD/EUR.
Situation: Payment due on Mayy 2: EUR 5,000,000.
SSep 2 = USD/EUR.
Problem: St is difficult to forecast  Uncertainty.
Uncertainty  Risk.
Example: on January 2, St > or < USD/EUR.
On SFeb 2, ABYZ total payment would be:
EUR 5,000,000 x USD/EUR = USD 5,750,000.
On May 2 we have two potential scenarios:
If the SMay 2 (USD appreciates)  ABYZ will pay less USD.
If the SMay 2 (USD depreciates)  ABYZ will pay more USD.
→ The second scenario introduces Currency Risk.
FX Risk: Hedging Tools
Hedging Tools:
- Market-tools:
Futures/Forward
Money Market (IRPT strategy)
Options
- Firm-tools:
Pricing in domestic currency
Risk-sharing
Matching Outflows and Inflows
Futures or Forward FX Contracts
Forward markets: Tailor-made contracts.
Location: none.
Reputation/collateral guarantees the contract.
Futures markets: Standardized contracts.
Location: organized exchanges
Clearinghouse guarantees the contract.
Comparison of Futures and Forward Contracts
Futures
Forward
Amount
Standardized
Negotiated
Delivery Date
Standardized
Negotiated
Counter-party
Clearinghouse
Bank
Collateral
Margin account
Negotiated
Market
Auction market
Dealer market
Costs
Brokerage and exchange fees
Bid-ask spread
Secondary market
Very liquid
Highly illiquid
Regulation
Government
Self-regulated
Location
Central exchange floor
Worldwide
FX Futures/Forwards: Basic Terminology
Short: Agreement to Sell.
Long: Agreement to Buy.
Contract size: number of units of foreign currency in each contract.
CME expiration dates: Mar, June, Sep, and Dec + Two nearby months
Margin account: Amount of money you deposit with a broker to cover your possible losses involved in a futures/forward contract.
Initial Margin: Initial level of margin ac