Fin Exam 2

6/7

Currency futures contract

legally binding agreement to buy or sell a commodity at a specified price at a predetermined future time. Each is standardized w:

• specific commodity

• quality

• quantity

• delivery date

• settlement

What happens when you Buy (or long) a futures contract

Gain when price goes up, lose when price goes down

How to calculate gain/loss

Price difference x contract size

What happens when you sell (or short) a futures contract?

Lose when price goes up, gain when price goes down

Performance bond

the good-faith security deposit required by a clearing house or broker when you open or write (sell) a currency option position

maintenance performance bond

Smaller minimum balance that must remain in the account

• previously maintenance margin

performance bond call

Demand for funds to restore the account to the initial level when the balance falls below maintenance

• previously margin call

Mark to market definition

An accounting method that measures the current market value of assets and liabilities based on what they would sell for today, rather than their original purchase price

What risks are you exposed to if you have a short position in pounds?

the risk of strengthening pound sterling

• hedge by doing a long futures contract

When a speculator goes short a futures contract, what does the speculator hope will happen before the position is closed?

that the futures price will decrease before the position is closed

A trader bought 10 March Japanese Yen futures contracts at the Chicago Mercantile Exchange. How would the trader close out this position in the market?

Selling 10 March contracts

Long =

bought

Short =

sold

Call definition

right, but not obligation to BUY a specific amount of currency with domestic currency @ a predetermined price (strike price)

Put definition

the right, but not obligation to SELL a specific amount of currency with domestic currency @ a predetermined price (strike price)

European options

can only be exercised at maturity date

American options

can be exercised any time until maturity date

ITM for a call

Strike < Spot (profit if option exercised)

ATM for a call

Strike = spot (no profit if option exercised)

OTM for a call

Strike > spot (no profit if option exercised)

ITM for a put

Strike > Spot (profit if option exercised)

ATM for a put

Strike = Spot (no profit if option exercised)

OTM for a put

Strike < Spot (no profit if option exercised)

Option value

time value + intrinsic value

intrinsic value =

immediate gain from exercising an option

• 0 when strike > spot price

what is the intrinsic value if the option is OTM?

0

time value

potential gain from the possibility that future price will move in-the-money or, when it is already in-the-money, move further in- the-money

Delta formula

Change in premium / change in spot rate

higher deltas mean…

there is a greater probability of the option expiring ITM

“Bullish” about underlying currency

• Expecting prices to rise and feeling optimistic about the market

Buy Call

"Bearish” about underlying currency

• Expecting prices to fall and feeling pessimistic or cautious

Buy Put

Speculation short straddle

selling a call and a put with the same strike price

• expecting volatility to decrease

speculation long straddle

buying a call and a put with the same strike price

• expecting volatility to increase

Floor price

Strike price of put - put premium

Ceiling price

Strike price of call + call premium

Call Buyer

Call Seller

Put Buyer

Put Seller

Profit/Loss potential Call Buyer

limited loss, unlimited profit

• Profit = Spot - (Strike + Prem)

Profit/Loss Put Buyer

limited loss, limited profit

• Profit = Strike - (Spot + Prem)

Profit/Loss Call Seller

limited profit, unlimited loss

• Profit = Prem - (Spot - Strike)

Profit/Loss Put Seller

limited profit, large loss

• Profit = Prem - (Strike - Spot)

Breakeven for a Call

Strike + Prem

Breakeven for a Put

Strike - Prem

Intrinsic value formula

(spot - strike) x contract size

Time value formula

premium - (spot - strike)

Value at maturity (short)

-NP x (spot - futures)

Value at maturity (long)

NP x (spot - futures)

Margin call restores to…

initial margin, not to maintenance.

Main risk of forwards

default risk

Main risk of futures

mark-to-market risk

Fees for forwards

Bid-Ask spread

Fees for futures

commission per “round turn”

Initial margin/performance bond

Funds deposited up front with broker/clearing house; varies by product and volatility