Tài chính doanh nghiệp - Chapter eight: Foreign currency futures market

1CHAPTER EIGHT FOREIGN CURRENCY FUTURES MARKET 1 CHAPTER OVERVIEW • Introduction • Contract specifications • Futures contract daily settlement • Hedging by Futures contract • Speculation using Futures contract 2 FOREIGN CURRENCY FUTURES • A foreign currency futures contract is an agreement for future delivery of an amount of foreign exchange at a fixed time, place, and price – Foreign currency futures are standard contracts traded on an exchange, but foreign exchange forward (FX forward) contracts are contracts traded in the over-the-counter market – The other differences between foreign currency futures and FX forward contracts are compared on Slide 12. • It is similar to futures contracts that exist for other underlying assets, like gold, cattle, Treasury bonds, etc. • The most important market in the world for foreign currency futures is the CME group – CME Group was created on July 12, 2007 from the merger between the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT) FUTURES CONTRACT – Many other exchanges throughout the world trade futures contracts: LIFFE, SOFFEX, TIFFE, SIMEX... – There are many kind of futures contracts: – Commodity futures contract, – Foreign currency futures contract, – LIBOR futures contract, – T-Bill futures contract and – Futures contract on S&P’s 500 Stock Index 2FUTURES CONTRACT # • Contracts of exchange-traded derivatives are standard contracts established by the exchange on which the derivatives are traded • Major features of the foreign currency futures that are standardized are as follows – Contract size (also called the notional principal) – Method of stating exchange rates (“American terms” are used, i.e., the US$ price of one foreign currency) – Maturity date (matured on the third Wednesday of Jan., Mar., Apr., Jun., Jul., Sept., Oct., and Dec.) – Last trading day (the second business day prior to the maturity date) – Commissions (Customers pay a commission to their broker for a round transaction, which differs from that in the interbank market, dealers earn the bid and ask spread and do not charge a commission) FUTURES CONTRACT – Settlement • Only 5% of all futures contracts are settled by the physical delivery of foreign exchange between buyer and seller • Most often, buyers and sellers offset their original positions prior to the delivery date by taking an opposite position – Collateral and margins • To prevent the default risk, both sellers and buyers must deposit a sum as the initial margin, which is a kind of cash collateral • The value of the contract is marked to market and all changes in value are paid from the margin account daily • Marked to market means that the value of the contract is revalued using the closing price for the day • If the balance of the margin account falls below the maintenance margin, the investor receives a margin call and needs to top up the margin account to the initial margin level the next day – Use of a clearing house as a counterparty (all contracts can be viewed as agreements between an investor and the exchange clearing house, rather than between two investors involved) FUTURES CONTRACT – The contract size specifies the amount of the asset that has to be delivered under one contract. Contract size for a contract vary from commodity to financial future. – The price agreed to by the two traders on the floor of exchange is known as the futures price. This price, like any other price, is determined by the laws of supply and demand. – A futures contract is refereed to by its delivery month. The exchange must specify the precise period during the month when delivery can be made. The delivery months vary from contract to contract. – Traders charge commissions on futures contracts rather than using the bid-ask spreads found in the forward market. – Futures contract can be closed out with an offsetting trade. – Profits and losses of futures contract are paid every day at the end of trading, it called marking to market FUTURES CONTRACT # – Performance bond (Margin) requirement reduces risk for investor’ s future. The initial margin shows how much money must be in the amount balance when the contract is entered into. – A Performance bond (margin) call is issued if the balance in the account falls below the maintenance margin that new money must be added to the account balance to bring it up to the maintenance margin. – Daily settlement reduces default risk of futures contract relative to forward contracts – Everyday, futures investors must pay over any losses or receive any gains from the day’s price movements. These gains or losses are generally added to or subtracted from the investor’s margin account. 3EXHIBIT 7.1 CONTRACT SPECIFICATIONS FOR FOREIGN CURRENCY FUTURES AUSTRALIA N DOLLAR BRITISH POUND CANADIAN DOLLAR JAPANESE YEN EURO FX MEXICAN PESO SWISS FRANC CONTRACT SIZE A$ 100,000 £62,500 C$ 100,000 ¥12,500,000 €125,000 P500,000 SFr 125,000 SYMBOL AD BP CD JY EC MP SF PERFORMANCE BOND REQUIREMENTS INITIAL $2,013 $1,320 $1,265 $3,850 $2,475 $2,035 $2,200 MAINTENANCE $1,830 $1,200 $1,150 $3,500 $2,250 $1,850 $2,000 MINIMUM PRICE CHANGE $0.0001 $0.0002 $0.0001 $0.000001 $0.0001 $0.000025 0.0001 (1pt.) (2pts.) (1pt.) (1pt.) (1pt.) (1pt.) VALUE OF 1 POINT $10.00 $6.25 $10.00 $12.50 $12.50 $12.50 $12.50 MONTHS TRADED March, June, September, December TRADING HOURS 7:20AM – 2:00PM (central time) LAST DAY OF TRADING The second business day immediately preceding the third Wednesday of the delivery month Source: Chicago Mercantile Exchange, contract highlight, July 2013 Table 7.3 FOREIGN EXCHANGE FUTURE QUOTES FROM THE WALL STREET Table 7.3 FOREIGN EXCHANGE FUTURE QUOTES FROM THE WALL STREET AN EXAMPLE OF DAILY SETTLEMENT WITH A FUTURES CONTRACT # Time Action Cash flow Tuesday morning Investor buys SFr futures contract that matures in two days. Price is $0.75 none Tuesday close Futures price rises to $0.755. Position is marked to market Investor receives 125,000 x(0.755-0.75) = $625 Wednesday close Futures price drops to $0.743. Position is marked to market Investor pays 125,000 x(0.755-0.743) = $1.500 Thursday close Futures price drops to $0.74. (1) Contract is marked to market (2) Investor takes delivery on SFr 125,000 (1) Investor pay 125,000 x (0.743-0.74) = $375 (2) Investor pays 125,000 x 0.74 = $95,500 Net loss on the futures contract = $1,250 4EXHIBIT 1 COMPARISONS BETWEEN CURRENCY FUTURES AND FORWARDS HEDGING USING FUTURES • Example, In Dec 2014, Company A, based in the US, knows that it will have to pay £1 millions in Jan. 2015. for goods it has purchased from a British supplier. The current exchange rate is $1.8220, and Jan. futures price for CME contracts on £ is $1.8250 • Solution: – Company A could hedge its foreign exchange risk by taking a long position in £1 million worth of Jan. futures contracts. Total of 16 contracts would have to be purchased. • Example, Company B, based in the US, export goods to UK and in Dec. 2014 knows that it will receive £3 millions in May 2015. The current exchange rate is $1.8220, and May futures price for CME contracts on £ is $1.8350 • Solution: – Company B could hedge its foreign exchange risk by taking a short position in £3 million worth of May futures contracts. Total of 48 contracts would have to be purchased. SPECULATION USING FUTURES • In February, US speculator think that £will appreciate to the US dollar over the next two months and is prepared to back that hunch to the tune of £250,000. • Solution: – One thing the speculator can do is simply purchase £250,000 hope that the sterling can be sold later at a profit. – Another possibility is to take a long position in four April futures contracts on sterling • Outcome: – Exchange rate is 1.7000 in two months. The investor makes $13.250 using the first strategy and $14,750 using the second strategy – Exchange rate is 1.6000 in two months. The investor has a loss of $11.750 using the first strategy and $10,250 using the second strategy