Foreign Exchange Derivatives Markets Role
Not what you're looking for?
Managers in multinational corporations use derivatives to hedge their exposure to currency risk. Therefore, they must understand different forms of currency derivatives and how the derivatives markets work.
How foreign exchange derivatives markets work.
Explain the role of derivatives in hedging the foreign currency risk.
Answer the following:
1. On Monday morning, an investor takes a long position in pound futures contract that matures on Wednesday afternoon. The agreed-upon price is $1.78 for 62,500 pound sterling. At the close of trading on Monday, the futures price has risen to $1.79. At Tuesday close the price rises further to $1.80. At Wednesday close, the price falls to $1.785, and the contract matures. The investor takes delivery of the pounds at the prevailing price of $1.785. Detail the daily settlement process (refer to exhibit 8.3). What will be the investor's profit (loss)?
.
2. The DEC buys a Swiss franc futures contract (contract size is SFr 125,000) at a price of $0.83. If the spot rate for the Swiss franc at the date of settlement is SFr1 = $0.8250, what is DEC's gain or loss on this contract?
3. Assume that the spot price of the British pound is $1.55, the annualized 30-day sterling interest rate is 10%, the annualized 30-day U.S. interest rate is 8.5%, and the annualized standard deviation of the dollar:pound exchange rate is 17%. Calculate the value of a 30-day PHLX call option on the pound at a strike price of $1.57.
4. On August 6, you go long one IMM yen futures contract at an opening price of $0.00812 with a performance bond of $4,590 and a maintenance performance bond of $3,400. The settlement prices for August 6, 7, and 8 are $0.00791, and $0.00845, and $0.00894, respectively. On August 9, you close out the contract at a price of $0.00857. Your round-trip commission is $31.48.
a. Calculate the daily cash flows on your account. Be sure to take into account your required performance bond and any performance bond calls.
b. What is your cash balance with your broker on the morning of August 10?
5. On June 25, the call premium on a December 25 PHLX contract is 6.65 cents per pound at a strike price of $1.81. The 180-day interest rate is 7.5% in London and 4.75% in New York. If the current spot rate is 1 pound sterling = $1.8470 and the put=call parity holds, what is the put premium on a December 25 PHLX pound contract with an exercise price of $1.81?
Purchase this Solution
Solution Summary
Over 1000 words explain the concepts of foreign derivative markets and answer two problems on it.
Solution Preview
How foreign exchange derivatives markets work:
The derivatives markets are the financial markets for derivatives. The market can be divided into two, that for exchange traded derivatives and that for over-the-counter derivatives.
The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest financial market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex and related markets currently is over US$ 3 trillion.[1] Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks, and are subject to forex scams. For more information please see the reference:
http://en.wikipedia.org/wiki/Foreign_exchange_market
Explain the role of derivatives in hedging the foreign currency risk:
One use of derivatives is as a tool to transfer risk by taking the opposite position in the futures market against the underlying commodity. For example, a farmer can sell futures contracts on a crop to a speculator before the harvest. By taking a position in the futures market, the farmer hopes to minimize his or her price risk.
Please see attached pdf files for more examples.
1. On Monday morning, an investor takes a long position in pound futures contract that matures on Wednesday afternoon. The agreed-upon price is $1.78 for 62,500 pound sterling. At the close of trading on Monday, the futures price has risen to $1.79. At Tuesday close the price rises further to $1.80. At Wednesday close, the price falls to $1.785, and the contract matures. The investor takes delivery of the ...
Purchase this Solution
Free BrainMass Quizzes
Change and Resistance within Organizations
This quiz intended to help students understand change and resistance in organizations
Cost Concepts: Analyzing Costs in Managerial Accounting
This quiz gives students the opportunity to assess their knowledge of cost concepts used in managerial accounting such as opportunity costs, marginal costs, relevant costs and the benefits and relationships that derive from them.
SWOT
This quiz will test your understanding of the SWOT analysis, including terms, concepts, uses, advantages, and process.
Six Sigma for Process Improvement
A high level understanding of Six Sigma and what it is all about. This just gives you a glimpse of Six Sigma which entails more in-depth knowledge of processes and techniques.
Managing the Older Worker
This quiz will let you know some of the basics of dealing with older workers. This is increasingly important for managers and human resource workers as many countries are facing an increase in older people in the workforce