The website of the Chicago Mercantile Exchange

Description

1. Risk of Currency Futures Currency futures
   markets are commonly used as a means of capitalizing
   on shifts in currency values, because the value of a
   futures contract tends to move in line with the change
   in the corresponding currency value. Recently, many
   currencies appreciated against the dollar. Most speculators
   anticipated that these currencies would continue
   to strengthen and took large buy positions in currency
   futures. However, the Fed intervened in the foreign
   exchange market by immediately selling foreign currencies
   in exchange for dollars, causing an abrupt
   decline in the values of foreign currencies (as the dollar
   strengthened). Participants that had purchased currency
   futures contracts incurred large losses. One
   prominent trader responded to the effects of the Fed’s
   intervention by immediately selling 300 futures contracts
   on British pounds (with a value of about $30
   million). Such actions caused even more panic in the
   futures market.
   a. Explain why the central bank’s intervention caused
   such panic among currency futures traders with buy
   positions.
   b. Explain why the prominent trader’s willingness to
   sell 300 pound futures contracts at the going marketrate aroused such concern. What might this action
   signal to other traders?
   c. Explain why speculators with short (sell) positions
   could benefit as a result of the central bank’s
   intervention.
   d. Some traders with buy positions may have
   responded immediately to the central bank’s intervention
   by selling futures contracts. Why would some
   speculators with buy positions leave their positions
   unchanged or even increase their positions by purchasing
   more futures contracts in response to the central
   bank’s intervention?
2. Estimating Profits from Currency Futures
   and Options One year ago, you sold a put option on
   100,000 euros with an expiration date of one year. You
   received a premium on the put option of $.04 per unit.
   The exercise price was $1.22. Assume that one year ago,
   the spot rate of the euro was $1.20, the one-year forward
   rate exhibited a discount of 2 percent, and the one-year
   futures price was the same as the one-year forward rate.
   From one year ago to today, the euro depreciated against
   the dollar by 4 percent. Today the put option will be
   exercised (if it is feasible for the buyer to do so).
   a. Determine the total dollar amount of your profit or
   loss from your position in the put option.
   b. Now assume that instead of taking a position in the
   put option one year ago, you sold a futures contract
   on 100,000 euros with a settlement date of one year.
   Determine the total dollar amount of your profit or loss.
   Use of Currency Futures and Options by the Sports Exports Company
   The Sports Exports Company receives British pounds
   each month as payment for the footballs that it exports.
   It anticipates that the pound will depreciate over time
   against the U.S. dollar.
3. How can the Sports Exports Company use currency
   futures contracts to hedge against exchange rate
   risk? Are there any limitations of using currency
   futures contracts that would prevent the Sports Exports
   Company from locking in a specific exchange rate at
   which it can sell all the pounds it expects to receive in
   each of the upcoming months?
4. How can the Sports Exports Company use currency
   options to hedge against exchange rate risk?
5. Are there any limitations of using currency options
   contracts that would prevent the Sports Exports Company
   from locking in a specific exchange rate at whichit can sell all the pounds it expects to receive in each of
   the upcoming months?
6. Jim Logan, owner of the Sports Exports Company,
   is concerned that the pound may depreciate substantially
   over the next month, but he also believes that the
   pound could appreciate substantially if specific situations
   occur. Should Logan use currency futures or
   currency options to hedge the exchange rate risk? Is
   there any disadvantage of selecting this method for
   hedging?
   The website of the Chicago Mercantile Exchange
   (www.cmegroup.com) provides information about currency
   futures and options.
7. Use this website to review the prevailing prices of
   currency futures contracts. Do today’s futures prices
   (for contracts with the closest settlement date) generally
   reflect an increase or decrease from the day before?
   Is there any news today that might explain the change
   in the futures prices?
8. Does it appear that futures prices among currencies
   (for the closest settlement date) are changing in the
   same direction? Explain.
9. If you purchase a British pound futures contract
   with the closest settlement date, what is the futures
   price? Given that a contract is based on £62,500, what
   is the dollar amount you will need at the settlement
   date to fulfill the contract?
10. Go to www.nasdaqtrader.com and under “Trading
    Products,” click on FX Options. Obtain the money
    currency option quotations for the Canadian dollar
    (the symbol is XCD) and the euro (symbol is XEU) for
    a similar expiration date. Which currency option has a
    larger premium? Explain your results.

Sample Solution