Question

Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses? [6 marks]

Answer 1

Currency futures, also called forex futures or foreign exchange futures, are exchange-traded futures contracts to buy or sell a specified amount of a particular currency at a set price and date in the future. Currency futures were introduced at the Chicago Mercantile Exchange (now the CME Group) in 1972 soon after the fixed exchange rate system and the gold standard were discarded. Similar to other futures products, they are traded in terms of contract months with standard maturity dates typically falling on the third Wednesday of March, June, September, and December.

Currency futures, also called forex futures or foreign exchange futures, are exchange-traded futures contracts to buy or sell a specified amount of a particular currency at a set price and date in the future. Currency futures were introduced at the Chicago Mercantile Exchange (now the CME Group) in 1972 soon after the fixed exchange rate system and the gold standard were discarded. Similar to other futures products, they are traded in terms of contract months with standard maturity dates typically falling on the third Wednesday of March, June, September, and December.

Unlike forex, wherein contracts are traded via currency brokers, currency futures are traded on exchanges that provide regulation in terms of centralized pricing and clearing. The market price for a currency futures contract will be relatively the same regardless of which broker is used. The CME Group offers 49 currency futures contracts with over $100 billion in daily liquidity, making it the largest regulated currency futures marketplace in the world. Smaller exchanges are present worldwide, including NYSE Euronext, the Tokyo Financial Exchange (TFX) and the Brazilian Mercantile and Futures Exchange (BM&F)

Traders and investors are drawn to markets with high liquidity since these markets provide a better opportunity for profiting. The emerging markets typically have very low volume and liquidity, and they will need to gain traction before becoming competitive with the other established contracts. The G10 contracts, the E-mini and the E-Micro contracts are the most heavily traded and have the greatest liquidity.

There are two primary methods of settling a currency futures contract. In the vast majority of instances, buyers and sellers will offset their original positions before the last day of trading (a day that varies depending on the contract) by taking an opposite position. When an opposite position closes the trade prior to the last day of trading, a profit or loss is credited to or debited from the trader's account.

Less frequently, contracts are held until the maturity date, at which time the contract is cash-settled or physically delivered, depending on the specific contract and exchange. Most currency futures are subject to a physical delivery process four times a year on the third Wednesday during the months of March, June, September, and December. Only a small percentage of currency futures contracts are settled in the physical delivery of foreign exchange between a buyer and seller. When a currency futures contract is held to expiration and is physically settled, the appropriate exchange and the participant each have duties to complete the delivery.