The website of the Chicago Mercantile Exchange

    Description 24. Risk of Currency Futures Currency futures markets are commonly used as a means of capitalizing on shifts in currency values, because the value of a futures contract tends to move in line with the change in the corresponding currency value. Recently, many currencies appreciated against the dollar. Most speculators anticipated that these currencies would continue to strengthen and took large buy positions in currency futures. However, the Fed intervened in the foreign exchange market by immediately selling foreign currencies in exchange for dollars, causing an abrupt decline in the values of foreign currencies (as the dollar strengthened). Participants that had purchased currency futures contracts incurred large losses. One prominent trader responded to the effects of the Fed’s intervention by immediately selling 300 futures contracts on British pounds (with a value of about $30 million). Such actions caused even more panic in the futures market. a. Explain why the central bank’s intervention caused such panic among currency futures traders with buy positions. b. Explain why the prominent trader’s willingness to sell 300 pound futures contracts at the going marketrate aroused such concern. What might this action signal to other traders? c. Explain why speculators with short (sell) positions could benefit as a result of the central bank’s intervention. d. Some traders with buy positions may have responded immediately to the central bank’s intervention by selling futures contracts. Why would some speculators with buy positions leave their positions unchanged or even increase their positions by purchasing more futures contracts in response to the central bank’s intervention? 25. Estimating Profits from Currency Futures and Options One year ago, you sold a put option on 100,000 euros with an expiration date of one year. You received a premium on the put option of $.04 per unit. The exercise price was $1.22. Assume that one year ago, the spot rate of the euro was $1.20, the one-year forward rate exhibited a discount of 2 percent, and the one-year futures price was the same as the one-year forward rate. From one year ago to today, the euro depreciated against the dollar by 4 percent. Today the put option will be exercised (if it is feasible for the buyer to do so). a. Determine the total dollar amount of your profit or loss from your position in the put option. b. Now assume that instead of taking a position in the put option one year ago, you sold a futures contract on 100,000 euros with a settlement date of one year. Determine the total dollar amount of your profit or loss. Use of Currency Futures and Options by the Sports Exports Company The Sports Exports Company receives British pounds each month as payment for the footballs that it exports. It anticipates that the pound will depreciate over time against the U.S. dollar. 1. How can the Sports Exports Company use currency futures contracts to hedge against exchange rate risk? Are there any limitations of using currency futures contracts that would prevent the Sports Exports Company from locking in a specific exchange rate at which it can sell all the pounds it expects to receive in each of the upcoming months? 2. How can the Sports Exports Company use currency options to hedge against exchange rate risk? 3. Are there any limitations of using currency options contracts that would prevent the Sports Exports Company from locking in a specific exchange rate at whichit can sell all the pounds it expects to receive in each of the upcoming months? 4. Jim Logan, owner of the Sports Exports Company, is concerned that the pound may depreciate substantially over the next month, but he also believes that the pound could appreciate substantially if specific situations occur. Should Logan use currency futures or currency options to hedge the exchange rate risk? Is there any disadvantage of selecting this method for hedging? The website of the Chicago Mercantile Exchange (www.cmegroup.com) provides information about currency futures and options. 1. Use this website to review the prevailing prices of currency futures contracts. Do today’s futures prices (for contracts with the closest settlement date) generally reflect an increase or decrease from the day before? Is there any news today that might explain the change in the futures prices? 2. Does it appear that futures prices among currencies (for the closest settlement date) are changing in the same direction? Explain. 3. If you purchase a British pound futures contract with the closest settlement date, what is the futures price? Given that a contract is based on £62,500, what is the dollar amount you will need at the settlement date to fulfill the contract? 4. Go to www.nasdaqtrader.com and under “Trading Products,” click on FX Options. Obtain the money currency option quotations for the Canadian dollar (the symbol is XCD) and the euro (symbol is XEU) for a similar expiration date. Which currency option has a larger premium? Explain your results.