Currency Futures

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• Currency Futures
• (Shapiro Chapter 8)

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The growth of exchange-traded derivatives
Millions of contracts traded
Source Futures Industry Association (1995
figures are estimates)
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Survey of Derivative Usage

• From the Wharton School derivative survey
• Survey of 350 US firms (ended 1998)
• Firms were selected randomly, grouped by size
  into large capitalization (capitalization greater
  than 250 million), medium capitalization (between
  50 and 250 million), and small (less than 50
  million)

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Percentage of Firms that Use Derivatives
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Currency Futures

• 1972 Chicago Mercantile Exchange opened the
  International Monetary Market (IMM) to trade
  currency futures (www.cme.com)
• Prior to 1972 futures existed by and large for
  commodities only
• Interest rate futures 1975 (CBOT Chicago Board
  of Trade), T-Bill futures 1976, Eurodollar
  interest rate futures in 1981
• Currency futures contracts
• Specify quantities of a given currency (buy/sell)
• Specified delivery date
• Specify price (exchange rate)

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• Futures contracts
• British pound
• Canadian dollar
• German Euro
• French Franc
• Swiss Franc
• Japanese Yen
• Australian Dollar
• New Zealand Dollar
• South African Rand
• Mexican Peso
• Go the Chicago Mercantile Exchange

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• Size of the contract is standardized
• Minimum price moves are specified
• Exchanges also set maximum daily price moves -
  when these limits are reached
• Instead of bid-ask spreads, traders charge
  commissions
• Round trip e.g. One buy and one sell costs 15
  i.e. 0.05 of the value of a sterling contract,
  average is 30 across all currencies
• Individuals are encouraged to participate in
  these markets

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• Volume is still smaller than that of forward
  markets but it is growing
• While the IMM is the dominant trader, others
  include
• London International Financial Futures Exchange
  (LIFFE)
• Chicago Board of Trade (CBOT)
• New York Mercantile Exchange (NYMEX)
• Singapore International Monetary Exchange (SIMEX)
• Philadelphia Board of Trade (PBOT)
• MidAmerica Commodities Exchange
• New Zealand Futures Exchange
• Tokyo International Futures Exchange
• Stockholm Options Market

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Settlement of a futures contract

• Futures contracts are marked to market
• Contracts expire two business days before the
  third Wednesday of the delivery month.
• Once a trade is confirmed, the clearing house
  becomes the legal counterparty to both the buyer
  and seller of the contract (unlike a forward
  contract)
• The exchange (CMEs Clearing House Division)
  guarantees both sides of a contract
• CME is financially backed by its clearing members
  as well as a Special Trust Fund
• To facilitate this, members have to furnish
  margins

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• Two kinds of margins
• Initial margin (Performance bond)
• Maintenance margin (Maintenance performance bond)
• Margins are revised periodically to reflect
  currency volatilities
• Example On Monday morning, you short (sell) one
  IMM yen futures contract containing 12,500,000
  at a price of 0.009433. Suppose the broker
  requires a performance bond (initial margin) of
  4,590 and a maintenance performance bond
  (maintenance margin) of 3,400. The settlement
  prices for Monday through Thursday are 0.009542,
  0.009581, 0.009375, and 0.009369, respectively.

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FUTURES CONTRACTS

• Disadvantages of futures
• 1.) Limited number of
• currencies
• 2.) Limited dates
• of delivery
• 3.) Rigid contract
• sizes.

• Advantages of futures
• 1.) Smaller
• contract size
• 2.) Easy liquidation
• 3.) Well-organized
• and stable market.

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Reading a Futures Quote
Highest and lowest prices over the lifetime of
the contract.
Daily Change
Closing price
Lowest price that day
Highest price that day
Opening price
Number of open contracts
Expiry month