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 contractsincurred large losses. One floor broker 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 on the futures market.
a) Explain why the central bank's intervention caused such panic for currency futures traders with buy positions.
b) Explain why the floor broker's willingness to sell 300 pound futures contracts at the going market rate aroused such
concern. What might this action signal to other brokers?
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 positionsunchanged or even increase their positions
by purchasing more futures contracts in response to the central bank's intervention?
a) Futures prices on pounds rose in tandem with the value of the pound. However, when central banks intervened to support
the dollar, the values of the pound declined, and so did values of futures contracts on pounds. So traders with long (buy)
positions in these contracts experienced losses because the contract values declined.
b) Normally, this order ...
This posting provides detailed answers to the student's questions.
Veblen: Discuss Derivatives, Future Contracts to Hedge Currency and Interest Rate Risk
Jim Herman is the treasurer of the midsized corporation, Veblen International. The firm manufactures various plastic components used in the computer hardware industry. When the firm opened up, it initially did business in the Midwest region of the United States but now sells its components to customers in other countries. Mr. Herman request that you report and discuss some issues relating to futures contracts, which might be used in the future by the firm to hedge currency risk and interest rate risk. Some of the issues he needs to know more about include the following:
* possible benefits to the firm in using the futures markets
* functions and importance of forward markets
* concept of daily settlement
* regulatory responsibilities of the National Futures Association and the Commodity Futures Trading Commission
Mr. Herman was enlightened by the information you provided on risk reduction, futures, and forwards contracts but would like to learn if there are alternative methods available for dealing with currency risks. He requests that you research material from the Library and/or the Internet to construct a memo on the differences between taking a long position in a futures contract and taking a short position in a futures contract. Also, give an example of a business scenario in which it would be appropriate to use each of the contracts. If you were going to receive 100,000 Japanese yen in 6 months and the current exchange rate was 10 yen equals 1 U.S. dollar, how many yen would you sell or buy in the forward market? Be sure to cite all references using the appropriate format.View Full Posting Details