FB Chapter On Currency Derivatives Essay Example

a particular price within an assigned period. To determine the forward discount or premium for the Mexican peso, subtract the 90-day forward rate ($.ADD) from the spot rate ($.10), divide by the spot rate ($.10), multiply by 360/90, and interpret the final result as either a discount or premium. The calculation yields -2%, which represents an 8% discount.

When entering into a forward contract, it is important to consider the possibility of the spot rate at the time of orientation being different from the negotiated forward rate. To hedge against future payables denominated in euros, a U.S. firm can purchase a call option in euros and fix the maximum price for euros. Conversely, purchasing a put option on euros can lock in the minimum exchange price and hedge against future receivables. Speculators who anticipate appreciation should buy a call option on Australian dollars during the option contract's duration, while those expecting depreciation should opt for a put option. For those who expect substantial depreciation over 10 years, buying a put option on Australian dollars is recommended. Factors that affect currency call option premiums include existing spot rates relative to strike prices, time prior to expiration dates, and currency variability. When comparing an at-the-money call option in euros versus British pounds with identical expiration dates and dollar values, it is suggested that euro options have lower premiums due to their lower volatility compared to pound options.The impact on currency put options is influenced by various factors including the current spot rate in relation to the strike price, the time before expiration date and the currency's volatility. Randy Reduced invested in a call option for British pounds with

a cost of $.2 per unit, a $1.45 strike price and a $1.46 spot rate at exercise time; resulting in $.01 net profit per unit when exercised, or $.02 net profit per unit inclusive of premium cost – thus yielding $312.50 net profit per option assuming 31,250 units exist in an option. Alice Diver purchased a put option on British pounds with a cost of $.04 per unit, a $1.80 strike price and $1.9 spot rate at exercise time; leading to -$0.21 net profit per unit upon exercising or -$0.17 inclusive of premium cost – equating to her making $5,312.50 net profit from one option given that 31,250 units are present in an option.Mike Usurer sold a call option on Canadian dollars at $.01 premium/unit and had no access to Canadian dollars until after exercising this option due to having received C$ worth less than they paid when purchasing them as part of their investment– leaving him with -$0.05 net profit/unit; hence earning him -$2,500 for one option if there are 50k units included within it.

Brian Tulle's sale of a put option on Canadian dollars at a premium of $.03 per unit resulted in a net profit of $0.03 per unit, assuming the strike price was $.75 and the spot rate at exercise was $.72 with 50,000 units in the option. While currency options offer more flexibility than forward contracts for hedging exposure to euros, there is a premium for call options above the exercise price specified in the contract. To capitalize on cyclical movements in the euro, one could use futures contracts on euros and analyze historical data and trends to determine profitability.

Buying futures when the euro strengthens and selling when it weakens can be profitable. For U.S. firms with no other foreign transactions, various anticipated transactions may arise such as Georgetown Co.

The following entities have various transactions that require hedging: Harvard, Inc. wishes to purchase Japanese goods denominated in yen; Yale Corp. has sold yen-denominated goods to Japan and needs to transfer funds from its Australian subsidiary to its U.S. parent; Brown, Inc. needs to pay off Canadian-dollar denominated loans; and Princeton Co. is considering purchasing a Japanese company in the future. The table below suggests different ways of hedging each transaction using forward contracts, futures contracts, and options.

Transaction | Forward Contract | Futures Contracts
-|-|-
A. Georgetown Co.|X|X|
B. Harvard, Inc.|X||X|
C.Yale Corp.|X||X|
D.Brown, Inc.||X|X|
E.Princeton Co.|X|||X|

To illustrate an example for trading on futures contracts, assuming that on November 1st the British pound's spot rate was $1.58 and by November 30th it had depreciated to $1.51 while the December futures contract's price was initially $1.59.One would wonder what happened to the futures price over the month of November and why.The expected spot rate on the December futures settlement date is likely to be close to the existing spot rate of $1.51 causing a decrease in December's futures price.If aware of this one could sell a December futures contract in pounds at the existing futures price of $1.59 then close out their position by buying a lower-priced future contract or fulfilling their obligation with currency purchased through spot market trade at an agreed rate of $1.59 per pound unit traded in advance through future contracts agreement or option payments as seen above under Transaction A-E respectively .During January, speculators had the opportunity

to buy peso futures for $.09 and sell forward at $.092 per unit. This move would allow them to take advantage of a potential decrease in the difference between the forward contract and futures price. Ultimately, on settlement day, these speculators could fulfill their obligation under the forward contract by selling off the pesos they received from their futures position.