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8.1 . Futures ontracLspo.eign cunency lutures nd optionscontracts reexamples f thenewbreedofI finangial nsrrumenr nown as derivatives. inancialderivativesarecontractsthatderive heir value rom someunderlyingassetsuchasa ,io.f.,.Uo"a, or curren_.cy),eferenceate suchasa 90-dayTreasurfblU ate;,o. t a.* i.rr.t, u, theSdzp 00

stock index). popular derivativej nclude-swaps, ;;..d.,"1i,,;;., and oprions.Chapter 7 discussed orward contracts,and Cha ter S aiscu.r", s*apr. This chapterdescribes he nature and valuation of *rr"*y frtur". ;;t"p,i"* contracts andshowshow they canbeused o manage.oreignexchange isk or Lke speculativepositiors on currencymovemenE. t atsoshows-how o .a"uat . p"a", of thesecontractsl]_t-hj1pn"ur " the.inancial ress. ppenclicese anaSB'airc";;; ie-Jfi;aspects t optionpricing.

275

iNNrsoN 1842)

8.1 FuruREs Coxiiecrs)e he organization

e to foMardnage unencyisk

as heyappear

nancebondaancebond calldhia Stockrange(PHLX)I option interestpaitytionrket

Cunency OptionsUCOM)r:rarket

TheChibagoMercantileExchangeCME)provides iroutlet orcurrencypecutatorsandfor thoseookine o redu"" hea_.u.r"rr.y i"f". r*a" -"-f."rlfr..'in.*.."i.yfutures,whicharecdntractso. sp"cincqrrniir;^; ;;;;;;;:,es; theexchanse#F+**:.tf fle-te ce439!51n1i'ednto, ni tre enuery'aar.'ffiDoarool drrectors l the International lvionetaryM-arIet.-These ontracbare pat_temed after those or grain and commodity futurescontra.,., ,t iatr't ru",l"en tradedon Chicago's xcbangesor over 100years__ .currency fururescontracb are cunently available or the Australiando[ar,lt:lg yl, Brirish pou4d, Canadiandollar, tzech k";; ;, ;ungarian forint,'ii.Xl,1i'"i,i,1,*fi ilii.li?i,liii!.'ili,1:lj::"X*.,',n,:***,'.f*inually experimenungwith new contracts.Those hat meetthe mrcquiremenr.qre added,and those hat do no#coprlaits,hrleroprr"e"ii.#i.i,.qir,lffiffitiffi'.: iT"lff#'fil;li:::"]l P-1F"9 the U.S. do ar out of rhe .qrrrior,, ..orr_*r; iu,,r.". allow one toneqgeouecuy the currency risk that arises n dealingwith no:rdollar currencies.Thenumber.otqontracts utstanding t anyone ime s called heopen rnrerest.Hnvatendl!'rduals reencouraged,ather handiscouraged,o pdrticipaten theyLdj^c91!t1:, :izesre sundardiz-edygmount { ore@?u-rrety rorexarnpre,t62;500, $i00,000,ndSFi125,000.xhibir .1shr*.';;;;;.;; "on.rtio* r*some-of he currencies iaded. Leverages high; margin requir"-"ii. "lr"."e" t.., tf,unz{, 9t tlrevalue.f the uturesontra-ct.he-everaleJ;J,h" j;;;;;;: i;;ffi;wur De eclded by tlny swings n exchange ates.tne contractshaveminimum price moves,which generally ranslate nto about$10-$12 per contract.At the sanie ime, most exchanges"..i "ir'i, oi* rrr"s on theircontracs that restrict the rnaKimumdaily price *ou"]wh.n tniJ iit tr are reached.

additionalarginequiremenbrempolaa"a ua"g til ldffi; ftffiil:::"--_lTf.d of.using.theid__askpreadsoundnihe'interbank arket,raders::1.i:-.::i*T]_':.. Tl!ust'^.g1n151ionsill varya round rip-that is,onebuyanoonesell--costsas irrleas$I5. Thiscostwork out to lesshan0.02%ofthe value

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276 CHAFTER8, CurrencyFutures ndOptons MarketsEXHIEIT 8 . t CONTRACT SPECIF ICATIONS FO R FOREIGN C U R R E N c YF U T U R E S *

AustralianDollar BritishPound CanadianDoIlar JapaneseYen MexicanPesoEuroFX SwissFranc

ContractsizeSymbolPerformance ondrequuementSlnitialMaintenanceMinimum pricechangeValueof I oointMonthshadedTradinghriursLastday of trading

A$100,000AD

$r,5t3$i , r50$0.000r(r pt.)$10.00

L62,500BP c$r00,000 125,000 Yr2,5oO,OOoCD EC JY P500,000 SFr125,000MP sF$1,875 $1,890$r,500 $1,400$0.000025 $0.0001(2.5pts.) G pr.)$5.00 $12.50

$1,620 $I,2r5 $2,565 $2,160$r,200 $900 - $1,900 $r,600$0.0002 $0.0001 $0.0001 $o.00ooor(?p!s) (l pr.) (l pr.) (t pr.)$6.25 $10.00 $12.50 $12.50March,une,September,ecember7:20A.M.-2:00 pM. (CentralTime)The second hnsine

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nd OF ignsMarke?

SFr125,000SF

$I,890$ ,.100$0.0001( r pL)$r2.50

d Wednesday f

everage,has pro-et. Other marketn curTencyassetsI with that n theforeign exchangeret are inked byradefuturescoh-on Intemationalthe Niwihe SingaporeB) n Frankfurt,des InstrumentgExchangadeals aresiruckare

contracb.markets

8.1 , FututesContracts

3:::,1,'lj:: ^:llT:9:,,h. exchange,slearingouse.-_backedyrtsmem_bers' capital-becomes the leeal cou't";,;; ;;;;, ;;"-T-.:L^cu uv rLsmem-6rt,,,o. ^-**^* .rL- -_:_L-- _ counterparty c both the buyer and se er of the*::::"::::::*:::1i:Fj--,"-b.*i'.fril;;ilfi :'i:: 'T:'J"j;l;largelyeliminating the defauii risks of trading.pon theircontrast,a fi contract sa private dealbetween wo panies*r. tl,.i.i,r", al ;; ;ilr. # ff ,:#,'"1ffi':;::J#jesandssubiFiohe

2a7can Swisso Franc000

3:":1"::*"9:tr:^Zdates onl;r n-hecase f theCME, hemosracdvelyraded ur_rency utures onuacts re for March,June,September,.andecemberelivefcomrac* expirewobusinessavsbefor.irt. ,itira w.Jn""i"r"r i." a"ir"..y--o",ri.Contract izes ndmatuririesrestandardized,."l;;;;;;;in the rnarket reB:-glt :h: ,rp.: ofcontractsuuluui",-u;i;#il'il;;;ormtes oadinq.rorwardcontracts, n theotherhand,areprivatedeals etweenwo inaivrJuafririocansrSn ny lpe of contracthev_agreen.Forexample,wo "di;j;;; ;lrlii'xforwardcontractor20,000n i0 iro!,}, . ;;;ili;:;; '#.r. However, ME::y:: :T9: :.Y.in rou1d.tsg!!125,000ricednus. aoi[i. ""a *itr, " nnit_ec range ot maturities available.With. only_a lw standardizedcontracts traded; thetrading volume in availablecontnprice lucruarions,ndo*., tru.,rltJiulifir; leadinSosuperioriquidiry, maller75l0t025.t5.,a

The conrract pecificationsn Exhibit.g.Lhovi;;;;n require,mentsnowcalled performance bonds bv the CME). if,. -r"r"A p.rf.iliri"e'bond (previouslyreferred o as he initial rnargin) snowshow much moneymust be in the accountbal_ancewhen the contract s entered-mo. This amount s $1,620 n the caseof thepound.Aperfonnanceondcall(form".lyr.f"..l;;;;;irr"ii"olu) ,, i.r,r.a r_becausef losses n the fuures co_ntracr_thealancen theaccountallsbelowthemaintenance erformance ond(formerly efened " ,; ,h; ;il;;;";;rgi"),which s.$1,200or_theound.Atthar,i.i ."ougf,"".t"""],rr:r" U "aded o he:::y:b*T. to bnng,t.up to thetnitialperforinanc.U"iJ.'no, "*-ple, supposeyoustartwithan nitialbalancef $1,770$150n excessf the.initiali"rid;;;;ondof$I,620) n youraccountna por.mdutures ontra.,nJfo* .o.rouctoses,say$680 l "31-o::t is now g1,090,whichis $rro belorv he'-#inrenanceperfor_flt:b::l :f $-l?P, .!9oge r.9g 1rstadd$:30 toyour.a.cul.rr.,iio "ettr," initiatperlcirmanceondequirerienii$r,zzo-$dd; ;j39:;i,iz;;: "'"" ure ruIurlr rne LIvrts penodically revises ts perlbrmancebond requirements n line with:lTg*q :1"""q volatiliries using a computerizedrisk "d;;;;;; "*;; ;i;;1p,{N,l'hl,;#Ji;;ffifi;ilr;iliffi1lT'frfffiTTl'fi:trI#}:liance ondrequirementsetbytheCMEar" -iu-".q L.of."JJtten requirehigh_erperformanceondson morevolatit"*.a"ay.ao.ltoJr.----'. -,,- Profisand osses f futures ontracts repaidovereverydayat theendof trad_ing, a practice alledmarkingto niarket. ri"', a.iry-.air"-riri, i"",u.. canbestbeilustraredwirhan examole.O-nuesday "rri.,g, "iiii"*i". -t"t". " to.,gporirion na Swissrancfuturescontrabtliat matureson-Thursdayaftemooi:The agreed_onprice s$0.75 or SFr125,000. o egin, the r,.,rerto.musl+!-oJiin" t i" "".ou.,, "r,

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CHAPTER. Cunency uturesndOptions arketsinitial performance ond of $1,g90.Ar the closeof tradingon li:esday the futuresrice hasrisen o $0.755.Because:f daily seui;.;;;,;;;?;ilgs occur.Firsr, heili{i:ix;::"1!;Tl.::ffi:it$3;fffi,"t**i:li;t"::*'$futures.conrracrith he_prevailingri.. "is,O;:;.'iir., ,iil"lr*" of rhe ururesontractss set o zeroat theend of eich tradingday^, __4tWednesdaylose, he pricehasdecline8 o '$0.743.The nrl^t:?99]:::rrr,oboo.olz5',"n.",r,",,ia"i ,;il#,"lTHfll'j iJ$;idZ."iJx"lilr;,xj[iJH"","*1"1,;f:*;#ii:t:l:ffi:;takesdelivery of the Swiss rancs, payrngthe prevailing pri* "f iO.Z+. The investorashad a net losson the contracrcommission.xhibir.2 ",.il.,h1t#ry2l3,[:x,"tJ:l'::"t37r b"f.;;;y;;;i.Dailysettlementeduceshea"f",itt *f. "iir,I.", .o",.r.o relativeo forward;:il'fi"'[?"1?*:H;:?f;TL.i,?,::*s"l,"x]l;m:r;"l:tractedromthe nvestorb ccount. n iriar"", i."l*r *irr a'ni.rriprotitabreositionouldbe forcednto defaultafter--onty.d"yb;'.rG ;'.#'i,ili, 0"r", allowed ouildup hugeosseshat ead o one arge efault t he'Jrneh" Irr,..",.u,ur", (u,il*f"fffiT:i fy#":ffi1"l' &'*-pL,ii'""l""*"'i"..'a"a,9.*n,r,mancebondcaribilJfflll"!*::i.j.T,;*i,iX?[H:'*ffiffi :i:$::anceondof $r,400.Hisnerformanceondcall ""ia ii-# sez5 $r,890625.-g-1,500.+$875 $i.890) r t..tos"ofw.an"lalli,Li"ingno.d".orn".,Ir'.Lt:9?9.:l*loerformance^bond:,r,r,r.,t " i""*i".rv"rilj'firvi ua toadd$875o nts account o maintain his futures contract.

8,1 , Futures ontaFutUfes ontracompanyson gpoally akedelivery f Ifutures onttacts n

tion.The wo positireceives ts profit ibetweenorwardan

ExHtBt r 8 .3 BrC(l. Trading:Forward odtracuFuturcs ontracG2. Regulation:The forwardmarlThe IMM is rcgulr3. Frequency f DelMoie rhar 90%olBy contrast,ess4. Sizeof Contract:Forward ontmctrcontracson theFutures ontncts5. DeliveryDate:Banksoffer forwaIMM futures onr6. Settlement:

Forward ontractFutures ontiactvaluesmay bewimarket.7. Quotes:Forwad pricesgrFutures ontEc&8. Transaction ostCostsof forwardFutulescontractr9. Margins:Margins renot rMarginsare rcqu10. Credit Risk:The credit risk isfor eachcustomeThe Exchange's. reducingcredit r

ExHrBrr8.2 }.lllx.AypLE oF DArLy SETTLEMENTwr rH A FUTURESCoNTRACTActioD ash FlowTuesdaymoming

Tues&y cloleWednesday loseThurs&y close

Investorbu}s SFr uturcscontract th_dimatures ntwo days.Frice s $O.75, 'Futuresprice rises o $0.755.Position s markedto markt.Fururesprice dropsto $0.743.Position s markedto market.Futuresprice drops to $0.7,1.(l) Connact is markedto market_(2) lnvesto! takesdelivery ofSFr125,000.

None

Investorreceives125,000 (0.755 0.75)= $625Investbrpa)s125,000 (0.755 0.7,t3): gr,500(I) tnvestor ays,-, 125,000x (0.743 0.7a)= $375(2, rnvestor aysl25,ooox 0.74 $g2,5ooNet osson the urures ontract= $1,250

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andOptionsMarketsresday,he futuresls occur.Fi6r, thecond, the existingitor recelves Rewue of the futuresstormust pay herd trade in the oldthe pdce drops to"the other sideand0.74.The nvestor) before palng hisrelative o forward' recelveany gainsr added o or sub-prcfitablepositionr being allowed torntractmatures asecidedto keephishavehada perfor-aintenanceperfor-, $875($1,8e0+rg n orderto meet: had o add$875

ExHrBrT 8 .3 FORWARD A ND

2'r9Futures ontracts analsobe closedoutwirh an offsetting trade. for example,fa.companysongposition n euro urureshasproved o beprofitable,t neednoiliter,

*.Y..:1f"d.l*:" "f the-euros hen he.contract atures. ath"r, h" company anselltuturescontracts n a like amounr,ofurosust prior to the maiurity of the ong position. The wo positions ancel n thebooksoI the futuresexchange,nd thecoipanyreceives ts profit in dollars. Exhibit g.3 summarizes these an'd other differencesbetween orward and futures contracs.

BASIc DIFFERENcEs BETWEENCoNTRAcrs FUTUREsl. Trading:Forward ontracts reuadedby telephone r telex.Futures ontnctsare radedn a compedrive rena.2. Regulation:

The forward market s self-regulating.^ The IMM-is regulatedby the CommodityFuturesTradingCommission.3. Frequencyof Delivery:More han90%ofall forwardconrracrsresededby actualdelivena. Bycon-rrast,essrhan1%of rhe IMM futurescontractsare settledUy delivery.4. Sizeof Contract:Forwardcontractsare ndividually tairoredand tend to be much rarger han thstandardizedconuacts n the ururesmarket.Futurescontractsarestandardizedn termsoI cuitency amount.5. DeliveryDate:Bank offer orwardcontractsor delivery n anydate.IMM furursconuactsare available