Question

5. a. what is a currency forward contract? How is it different from s futures contract?

  b. What are currency futures contracts? How can currency futures be used by Koo Int. Ltd?
      If you were a speculator, in which way would you make use of currency futures?

C.When is a currency put option said to be “in the money”, “at the money” and “out of the
      money”?

Answer 1

a) Currency forward contract:

A currency forward contract is one which locks the exchange rate for purchasing or selling the currency at a future date. It is necessary a hedging tool and doesn’t involve any upfront payment. The other main advantage of currency forward is that it can be tailored for a particular amount and period. Settlement of such contracts can be either in cash or on delivery process provided it is mutually accepted and specified well in advance in the contract. These are usually over the counter instruments and can’t be traded in a centralized exchange.

The main difference between forward and futures contract is that futures are publicly traded in stock exchanges while forwards are privately traded. Moreover futures are usually used for speculation. Futures are traded in the primary market and lower the counter party risk. Whereas forwards are traded in both primary and secondary markets and has high counter party risk. The futures markets are regulated by the government through commodity futures trading commission whereas forwards are not regulated.

b) Currency futures are those to buy or sell a specified amount of a particular currency at a set price and date in the future. They were introduced at the Chicago mercantile exchange in 1972. They are traded in terms of contract months with standard maturity dates. They are traded in exchanges and are regulated in terms of centralized price and clearing.

Use of currency futures by speculators:

Speculators are considered to be controversial group in the stock markets. Speculators generally trade in the futures market only with the intention of making profits and not for hedging foreign exchange risk. The speculators generally adopt some working model of exchange rates that help them in predicting movements.

Speculators generally make profits in the futures markets with the help of hedgers. Hedgers have a fundamental currency risk which they want to avoid. For avoiding this, they pay speculators a premium in the form of excess return for taking on their currency risk. They also use superior forecasting techniques to derive profits. They use technical trading rules or charting techniques

A long ten year sample of weekly positions in the futures market and prices of individual futures contracts are used to calculate the profitability.

c) A put option is said to be in the money is the strike price of the security is more than the current spot price of the security.

I.e. spot – strike < 0

A put option is said to be at the money if the strike price is equal to the current spot price of the security

I.e. spot – strike = 0

A put option is said to be out of the money if the strike price is less than the current spot price of the security.

I.e. spot – strike > 0