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Multinational Financial Management Alan Shapiro 7th EditionJ.Wiley & SonsPower Points byJoseph F. Greco, Ph.D.California State University, Fullerton
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PART I.FUTURES CONTRACTS
I.CURRENCY FUTURESA. Background
1. 1972: Chicago Mercantile
Exchange opens International Monetary Market. (IMM)
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FUTURES CONTRACTS
2. IMM providesa. 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.
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FUTURES CONTRACTS
c. Available Futures Currencies:
1.) British pound 5.) Euro
2.) Canadian dollar 6.) Japanese yen3.) Deutsche mark 7.) Australian dollar4.) Swiss franc
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FUTURES CONTRACTS
d. Standard Contract Sizes:contract sizes differ for each of the 7 available currencies.
Examples:Euro = 125,000
British Pound = 62,500
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FUTURES CONTRACTS
e. Transaction costs:payment of commission to a
traderf. Leverage is high
1.) Initial margin required isrelatively low (e.g. less
than .02% of sterling contract value).
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FUTURES CONTRACTS
g. Maximum price movements1.) Contracts set to a daily
price limit restricting maximum daily
price movements.
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FUTURES CONTRACTS
2.) If limit is reached, a margin
call may be necessary to
maintain a minimum
margin.
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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
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FUTURES CONTRACTS
4.) S.I.M.E.X.Singapore International
Monetary Exchange
5.) H.K.F.E. Hong Kong Futures
Exchange
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FUTURES CONTRACTSB. Forward vs. Futures Contracts
Basic differences:1. Trading Locations 6. Settlement
Date2. Regulation 7. Quotes3. Frequency of 8. Transaction
delivery costs 4. Size of contract 9. Margins5. Delivery dates 10. Credit risk
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FUTURES CONTRACTSAdvantages of futures:
1.) Smaller contract size
2.) Easy liquidation
3.) Well- organizedand stable
market.
Disadvantages of futures:
1.) Limited to 7 currencies
2.) Limited dates of delivery
3.) Rigid contract sizes.
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PART IICURRENCY OPTIONS
I. OPTIONSA. 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.
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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.
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CURRENCY OPTIONS
5. Types of Currency Options:a. Americanexercise date may occur anytime up to the expiration date.b. Europeanexercise date occurs only at theexpiration date.
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CURRENCY OPTIONS
7. Exercise Pricea. Sometimes known as the
strike price.b. the exchange rate at
which the option holder can buy or sell the contracted currency.
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CURRENCY OPTIONS
8. Status of an optiona. In-the-money
Call: Spot > strikePut: Spot < strike
b. Out-of-the-moneyCall: Spot < strikePut: Spot > strike
c. At-the-moneySpot = the strike
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CURRENCY OPTIONSB. When to Use Currency Options
1. For the firm hedging foreignexchange risk
a. With sizable unrealized gains.
b. With foreign currency flows forthcoming.
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CURRENCY OPTIONS
C. Option Pricing and Valuation
1. Value of an option equals
a. Intrinsic value
b. Time value
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CURRENCY OPTIONS
2. Intrinsic Valuethe amount in-the-money
3. Time Valuethe amount the option is inexcess of its intrinsic value.
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CURRENCY OPTIONS
4. Other factors affecting the value of an optiona. value rises with longer
time to expiration.b. value rises when
greater volatility in the exchange rate.
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CURRENCY OPTIONS
D. Using Forward or Futures Contracts:
Forward and futures contracts are more suitable for hedging a known amount of foreign currency flow.
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