Currency Derivatives Essay Example

very little risk of depreciation, may be more willing to buy futures than call options, because they do not need to insure against depreciation. However, speculators who expect appreciation but want to cover against possible depreciation may be willing to buy call options so that their downside risk is limited to what they pay for the call option. Answers to End of Chapter Questions 1. Forward versus Futures Contracts. Compare and contrast forward and futures contracts.

ANSWER:

Because currency futures contracts are standardized into small amounts, they can be valuable for the speculator or small firm (a commercial bank’s forward contracts are more common for larger amounts). However, the standardized format of futures forces limited maturities and amounts.  Using Currency Futures. a. How can currency futures be used by corporations?

ANSWER:

U. S. corporations that desire to lock in a price at which they can sell a foreign currency would sell currency futures. U. S. corporations that desire to lock in a price at which they can purchase a foreign currency would purchase currency futures. . How can currency futures be used by speculators?

ANSWER:

Speculators who expect a currency to appreciate could purchase currency futures contracts for that currency. Speculators who expect a currency to depreciate could sell currency futures contracts for that currency. Currency Options. Differentiate between a currency call option and a currency put option.

ANSWER:

A currency call option provides the right to purchase a specified currency at a specified price within a specified period of time. A currency put option provides the right to sell a specified currency for a specified price

within a specified period of time. . Forward Premium. Compute the forward discount or premium for the Mexican peso whose 90-day forward rate is $. 102 and spot rate is $. 10. State whether your answer is a discount or premium. ANSWER: (F - S) / S =($. 098 - $. 10) / $. 10 ? (360/90) = –. 02, or –2%, which reflects a 8% discount 5. Effects of a Forward Contract. How can a forward contract backfire?

ANSWER:

If the spot rate of the foreign currency at the time of the transaction is worth less than the forward rate that was negotiated, or is worth more than the forward rate that was negotiated, the forward contract has backfired.

Hedging With Currency Options. When would a U. S. firm consider purchasing a call option on euros for hedging? When would a U. S. firm consider purchasing a put option on euros for hedging? ANSWER: A call option can hedge a firm’s future payables denominated in euros. It effectively locks in the maximum price to be paid for euros. A put option on euros can hedge a U. S. firm’s future receivables denominated in euros. It effectively locks in the minimum price at which it can exchange euros received. 7. Speculating With Currency Options. When should a speculator purchase a call option on Australian dollars?