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Tutorials Questions: Chapter 8: Currency Futures and Options Markets 1

Here are the responses to the problems: 1. The basic difference between a currency forward market and a futures market is that in a forward market, contracts are customized as to amount and maturity date, and thus there is no liquid secondary market. Futures contracts are standardized as to amount and maturity date, and thus there is a liquid secondary market where contracts can be offset prior to maturity. 2. For a derivatives market to function efficiently, it needs both hedgers and speculators. Hedgers use derivatives like futures or options to offset risks from price changes. Speculators assume the counterparty risk, providing liquidity to the market. 3. The major difference between a futures/forward contract and an options contract is that

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251 views3 pages

Tutorials Questions: Chapter 8: Currency Futures and Options Markets 1

Here are the responses to the problems: 1. The basic difference between a currency forward market and a futures market is that in a forward market, contracts are customized as to amount and maturity date, and thus there is no liquid secondary market. Futures contracts are standardized as to amount and maturity date, and thus there is a liquid secondary market where contracts can be offset prior to maturity. 2. For a derivatives market to function efficiently, it needs both hedgers and speculators. Hedgers use derivatives like futures or options to offset risks from price changes. Speculators assume the counterparty risk, providing liquidity to the market. 3. The major difference between a futures/forward contract and an options contract is that

Uploaded by

ngan phan
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 8: CURRENCY FUTURES AND OPTIONS MARKETS 1

Tutorials Questions

1. Explain the basic differences between the operation of a currency forward market and a
futures market.
2. In order for a derivatives market to function most efficiently, two types of economic
agents are needed: hedgers and speculators. Explain.
3. What is the major difference in the obligation of one with a long position in a futures (or
forward) contract in comparison to an options contract?
A futures (or forward) contract is a vehicle for buying or selling a stated amount of
foreign exchange at a stated price per unit at a specified time in the future. If the long
holds the contract to the delivery date, he pays the effective contractual futures (or
forward) price, regardless of whether it is an advantageous price in comparison to the
spot price at the delivery date. By contrast, an option is a contract giving the long the
right to buy or sell a given quantity of an asset at a specified price at some time in the
future, but not enforcing any obligation on him if the spot price is more favorable than
the exercise price. Because the option owner does not have to exercise the option if it is
to his disadvantage, the option has a price, or premium, whereas no price is paid at
inception to enter into a futures (or forward) contract.

Tutorials Problems

1. Long Position
On Monday morning, an investor takes a long position in a pound futures contract that
matures on Wednesday afternoon. The agreed-upon price is $1.78 for £62,500. At the close
of trading on Monday, the futures price has risen to $1.79. At Tuesday close, the price rises
further to $1.80. At Wednesday close, the price falls to $1.785, and the contract matures.
The investor takes delivery of the pounds at the prevailing price of $1.785. Detail the daily
settlement process (see Exhibit 8.3). What will be the investor's profit (loss)?
CHAPTER 8: CURRENCY FUTURES AND OPTIONS MARKETS 2

2. Short position

On Monday morning, an investor takes a short position in a euro futures contract that
matures on Wednesday afternoon. The agreed-upon price is $0.9370 for €125,000. At the
close of trading on Monday, the futures price has fallen to $0.9315. At Tuesday close, the
price falls further to $0.9291. At Wednesday close, the price rises to $0.9420, and the
contract matures. The investor delivers the euros at the prevailing price of $0.8420. Detail
the daily settlement process (see Exhibit 8.2). What will be the investor's profit (loss)?

3. A speculator is considering the purchase of five three-month Japanese yen call options
(¥1,000,000 each) with a striking price of 96 cents per 100 yen. The premium is 1.35 cents
per 100 yen. The spot price is 95.28 cents per 100 yen and the 90-day forward rate is 95.71
cents. The speculator believes the yen will appreciate to $1.00 per 100 yen over the next
three months. As the speculator’s assistant, you have been asked to prepare the following:

a. Graph the call option cash flow schedule.


CHAPTER 8: CURRENCY FUTURES AND OPTIONS MARKETS 3

b. Determine the speculator’s profit if the yen appreciates to $1.00/100 yen.


c. Determine the speculator’s profit if the yen only appreciates to the forward rate.
d. Determine the future spot price at which the speculator will only break even.

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