BMGT446: Currency Futures

derivative or contingent claim securities

are derived from or contingent upon the value of the underlying security

speculation

use of derivative instruments to take a position and attempt to profit from a change in price

hedging

use of derivative instruments to avoid price variation and reduce risk

forward and future contracts

derivative securities that involve an agreement to buy or sell an asset in the future at prices agreed upon today

forward

a binding agreement to buy/sell an asset at a specific time in the future, at a price chosen today

-quantity of the asset to be delivered by the seller

-delivery conditions (time,date)

-price paid by the buyer, the forward price

tailor-made

forward are ____-____ for a client by their international bank

futures contracts

are standardized contracts trading on organized exchanges with daily resettlement through a clearinghouse

trading location

futures: traded competitively on organized exchanges

forward: traded by bank dealers via a network of telephones and computerized dealing systems (OTC)

contractual size

futures: standardized amount of the underlying asset

forward: tailor-made to the needs of the participant

settlement

futures: daily settlement, or marking-to-market, done by the futures clearinghouse through the participant’s performance bond account

forward: participant buys or sells the contractual amount of the underlying asset from the bank at maturity at the forward (contractual) price

delivery

futures: delivery of the underlying asset is seldom made

forward: delivery of the underlying asset is commonly made

trading costs

futures: bid-ask spread plus broker’s commission

forward: bid-ask spread plus indirect bank charges via compensating balance requirements

performance bond

must be deposited into a collateral account to establish a futures position

-generally equal to 2% of contract value

-cash or t-bills may be used to meet requirements

price goes down

-long pays the short because the long had locked in a price that is now higher than the current price

-this is paid from the performance bond account

price goes up

-short pays the long because the long had locked in a price that is lower than the current price

-this is paid from the performance bond account

maintenance performance bond level

if performance account falls below this, additional funds must be deposited into the account to bring it back

standardized expiration dates

most CME currency futures have March, June, Sept, and Dec expiration, six quarters into the future, with the delivery date being the third Wed of the expiration month

standardized amounts

last day of trading for most contracts is the second business day prior to the delivery date