Podcast
Questions and Answers
How does daily resettlement, as seen in futures contracts, impact market participants?
How does daily resettlement, as seen in futures contracts, impact market participants?
- It requires participants to physically exchange the underlying asset daily, increasing transaction costs.
- It allows participants to realize their profit or loss on a day-to-day basis, effectively creating a new contract each day at the new price. (correct)
- It consolidates all profit/loss calculations until the contract's maturity date, reducing daily volatility.
- It delays the realization of profits or losses until the end of the contract, encouraging longer-term speculation.
In the context of currency futures contracts, what is the key distinction between speculators and hedgers?
In the context of currency futures contracts, what is the key distinction between speculators and hedgers?
- Speculators aim to profit from anticipated price changes, while hedgers seek to avoid price variation by locking in a purchase or sales price. (correct)
- Speculators aim to mitigate price variation by locking in future prices, while hedgers profit from expected currency depreciations.
- Speculators are primarily concerned with the physical delivery of the currency, whereas hedgers focus on financial settlements.
- Speculators operate exclusively in forward markets, while hedgers utilize futures markets for their risk management strategies.
What is the role of initial performance bond/margin in a futures contract?
What is the role of initial performance bond/margin in a futures contract?
- It serves as a prepayment for the underlying asset to be delivered at the contract's maturity.
- It is a 'good faith money' ensuring that the contract will be fulfilled, typically around 2% of the contract value. (correct)
- It represents the total profit or loss that the contract holder expects to realize at the end of the contract.
- It is a fee paid to the exchange for facilitating the trading of the futures contract.
If a trader holds a long position in a currency futures contract and the price of the currency decreases, what action occurs as part of the daily resettlement process?
If a trader holds a long position in a currency futures contract and the price of the currency decreases, what action occurs as part of the daily resettlement process?
How do currency futures differ from forward contracts?
How do currency futures differ from forward contracts?
What does it mean when a currency call option is described as 'in the money'?
What does it mean when a currency call option is described as 'in the money'?
A currency trader wants to protect against a potential decline in the value of the British pound (GBP) they expect to receive in three months. Which strategy would best achieve this?
A currency trader wants to protect against a potential decline in the value of the British pound (GBP) they expect to receive in three months. Which strategy would best achieve this?
Which of the following is a standardizing feature of futures contracts?
Which of the following is a standardizing feature of futures contracts?
In reading currency futures quotes, 'open interest' indicates:
In reading currency futures quotes, 'open interest' indicates:
What distinguishes European options from American options?
What distinguishes European options from American options?
A speculator believes the Euro will depreciate against the U.S. dollar. According to the content, which action is most aligned with this belief?
A speculator believes the Euro will depreciate against the U.S. dollar. According to the content, which action is most aligned with this belief?
What scenario would most likely lead a holder of a short futures position to receive a margin call?
What scenario would most likely lead a holder of a short futures position to receive a margin call?
In futures terminology, what term describes the seller of a futures contract?
In futures terminology, what term describes the seller of a futures contract?
A trader holds a long position in a currency futures contract. How can they exit the market prior to the delivery date?
A trader holds a long position in a currency futures contract. How can they exit the market prior to the delivery date?
What is the maximum loss a purchaser of a call option faces?
What is the maximum loss a purchaser of a call option faces?
A trader who is 'long' a currency future will profit if:
A trader who is 'long' a currency future will profit if:
A firm wants to protect against the risk of the Canadian dollar appreciating. Should they write a call or a put option?
A firm wants to protect against the risk of the Canadian dollar appreciating. Should they write a call or a put option?
What is the difference between future contracts and option contracts?
What is the difference between future contracts and option contracts?
Assuming that theoretical future rate does not equal to the actual future rate, what does that imply?
Assuming that theoretical future rate does not equal to the actual future rate, what does that imply?
If one were to buy a currency forward contracts rather than a currency future, what are they likely trying to achieve?
If one were to buy a currency forward contracts rather than a currency future, what are they likely trying to achieve?
Flashcards
Currency Future
Currency Future
A contract obligating the buyer to purchase, or seller to sell, a specific amount of currency for another at a predetermined exchange rate on a specific future date.
Initial Performance Bond / Margin
Initial Performance Bond / Margin
A deposit made to a clearinghouse to cover potential losses; ensures the contract will be fulfilled.
Maintenance Performance Bond
Maintenance Performance Bond
The minimum amount that market participants must maintain in their account.
Daily Resettlement
Daily Resettlement
Signup and view all the flashcards
Speculators
Speculators
Signup and view all the flashcards
Hedgers
Hedgers
Signup and view all the flashcards
Option Contract
Option Contract
Signup and view all the flashcards
Call Option
Call Option
Signup and view all the flashcards
Put Option
Put Option
Signup and view all the flashcards
Exercise/Strike Price
Exercise/Strike Price
Signup and view all the flashcards
Premium
Premium
Signup and view all the flashcards
Long
Long
Signup and view all the flashcards
Short/Writer
Short/Writer
Signup and view all the flashcards
Call Option: In the Money
Call Option: In the Money
Signup and view all the flashcards
Call Option: Out of the Money
Call Option: Out of the Money
Signup and view all the flashcards
Put Option: In the Money
Put Option: In the Money
Signup and view all the flashcards
Put Option: Out of the Money
Put Option: Out of the Money
Signup and view all the flashcards
Options Trading: Speculation
Options Trading: Speculation
Signup and view all the flashcards
Options vs. Futures: Obligation
Options vs. Futures: Obligation
Signup and view all the flashcards
Future contract costs and profit.
Future contract costs and profit.
Signup and view all the flashcards
Study Notes
Currency Futures Contracts
- A currency future is a contract standardizing the purchase or sale of a currency for another at a specific future date, with a predetermined exchange rate
- Currency futures are like forward contracts because they specify an exchange of currencies at a specified future date and price
- Futures are standardized contracts traded on organized exchanges, involving daily resettlement via a clearinghouse
Over-the-Counter (Forwards) vs Exchange-Traded (Futures)
| Feature | Future | Forward |
|---|---|---|
| Trading Venue | Competitively on organized exchanges | Traded by bank dealers |
| Underlying Asset Amount | Standardized | Tailor-made to participant's needs |
| Settlement | Daily, through futures clearinghouse using a performance bond account | At maturity, buyer/seller exchanges contractual amounts |
| Delivery Date | Standardized | Tailored to investor's needs |
| Asset Delivery | Rarely occurs; typically offset by a reversing trade | Common |
| Transaction Cost | Bid-ask spread plus broker's commission | Bid-ask spread plus indirect bank charges |
- Clients seeking futures must contact a specialized broker
Key Terminology
- Long refers to the buyer
- Short refers to the seller
- Initial performance bond/margin is ~2% of contract value; it is "good faith money" for fulfilling the contract
- Maintenance performance bond is the minimum account level participants must maintain
Standardized Features of Futures
- Contract size (CME)
- Delivery month (March, June, September, December)
- Daily resettlement
Theoretical Future Rate
- The IRP equation applies equally to forwards and futures
- Theoretical future rate = Spot rate x (1 + domestic interest rate) / (1 + foreign interest rate)
- If the theoretical future rate does not equal the actual future rate, IRP is not holding
Reading Currency Future Quotes
- Settle is the closing price at the end of the trading day
- Open interest indicates the number of contracts outstanding for a particular delivery month and is a good indicator of demand
- Displayed using American terms
- Prices are specified to four decimal places
Daily Resettlement
- Daily resettlement involves market participants realizing profit/loss daily rather than at maturity
- Each party has a a new contract at the new price
Impact of Price Movements
- If the rates goes down, the long position pays the short position
- If the rate goes up, the short position pays the long position
Hedging and Speculation
- Speculators attempt to profit from changing futures prices by taking short or long positions
- Speculators sell currency expected to depreciate and buy currency expected to appreciate
- Hedgers avoid price variation by locking in a purchase price or sales price
- Hedgers use risk management to transfer price variation risk to speculators, who are more willing to bear it
Option Contracts vs Future Contracts
- An options contract conveys the right, but not the obligation, to buy/sell a given quantity of an asset in the future at prices agreed upon today
- Available including individual stocks, stock indexes, futures, and foreign exchange
- Call options grant the holder the right to buy
- Put options grant the holder the right to sell
- European options can be exercised only on the expiration date
- American options can be exercised any time up to and including the expiration date
Option Specifics
- Premium is the price of the option contract
- Exercise/strike price is the exchange rate at which the option holder can buy/sell the currency
- Long refers to the buyer
- Short/writer refers to the seller
Call Option Expressions
- Call options-you want the underlying asset to become more expensive so that your option to buy is worth more
- In the money is when the exercise price is less than the spot price of the underlying asset
- At the money is when the exercise price equals the spot price of the underlying asset
- Out of the money is when the exercise price is more than the spot price of the underlying asset
Put Option Expressions
- Put options-you want the underlying asset to become more expensive so your option to sell it is worth more
- In the money is when the exercise price is greater than the spot price of the underlying asset
- At the money is when the exercise price equals the spot price of the underlying asset
- Out of the money is when the exercise price is less than the spot price of the underlying asset
Currency Options
- Currency options started trading on exchanges in 1982 and are in seven major currencies against the dollar
Option Values
- If a call is in the money, it is worth CT = ST −E
- If a call is out of the money, it is worthless
- If a put is in the money, it is worth PT = E − ST
- If a put is out of the money, it is worthless
Option Strategies
- Speculators purchase call options on currencies they expect to appreciate
- If correct, speculators realize a profit, and if incorrect, losses are limited to the call premium
- Speculators sell/write put options on currencies they expect to appreciate
- If correct, speculators realize profit (the put premium), but if incorrect, large losses may occur
- Speculators sell/write call options on currencies they expect to depreciate
- If correct, speculators realize profit (the call premium), but if incorrect, large losses may occur
- Speculators purchase put options on currencies they expect to depreciate
- If correct, speculators realize profit, and if incorrect, losses are limited to the put premium
Key Differences: Options vs. Futures
- Options give the buyer the right, but not the obligation, to buy/sell
- Future contracts obligate the buyer to buy, or the seller to sell specific currency
- Options require a premium, which is the maximum loss
- Future contracts involve a profit/loss calculated daily with unlimited risk and reward
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
