Currency Futures and Forwards

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Currency Futures and Forwards
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Outline

• Meaning of Futures
• Features of Futures Contracts
• Using Futures for Hedging and Speculation
• Meaning of Forwards
• Features of Forward Contracts
• Using Forwards for Hedging and Speculation

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Futures Contracts

• A futures contract is an agreement to buy or sell
  a specified quantity of a specified asset at a
  certain point in the future at a price agreed
  upon today
• In the case of currencies, it is an agreement to
  buy/sell a specified quantity of a specific
  currency at a pre agreed upon exchange rate at a
  certain time in the future

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Currency Futures

• Trade on an organized exchange
• Futures contracts are standardized with regard to
  the following
• The asset on which you trade a futures contract
• The contract size
• Delivery arrangements
• Daily price movement limits-limit up and limit
  down
• Position limits
• Mark to Market on a daily basis

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Corporate Use of Currency Futures

• Hedge open positions in foreign currencies by
  buying/selling currency futures
• Foreign currency cash inflows
• Risk domestic currency may appreciate
• Strategy sell foreign currency in the futures
  market at the futures exchange rate (Short)
• Foreign currency cash outflows
• Risk domestic currency may depreciate
• Strategy buy foreign currency in the futures
  market at the futures exchange rate (Long)

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Forward Contracts

• Agreement to buy or sell an asset at a certain
  time in the future for a predetermined price
• Over-the-counter product that do not trade on any
  organized exchange
• Delivery date can be any date that is mutually
  convenient to both the parties to the contract
• Size can be customized
• Not marked-to-market daily

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Hedging and Speculation using Forwards

• Expect a currency to appreciate
• Buy that currency forward (Long Position)
• Expect a currency to depreciate
• Sell that currency forward (Sell Position)
• Profit/Loss in a long position
• ST K
• Profit/Loss in a short position
• K ST
• Where ST is the spot exchange rate at maturity
  and K is the forward exchange rate at which you
  buy/sell a currency forward.