Currency Currency Futures and Futures and

ForwardsForwards

OutlineOutline• Meaning of Futures• Features of Futures Contracts• Using Futures for Hedging and

Speculation• Meaning of Forwards• Features of Forward Contracts• Using Forwards for Hedging and

Speculation

Futures ContractsFutures Contracts• A futures contract is an agreement to buy

or sell a specified quantity of a specified asset at a certain point in the future at a price agreed upon today

• In the case of currencies, it is an agreement to buy/sell a specified quantity of a specific currency at a pre agreed upon exchange rate at a certain time in the future

Currency FuturesCurrency Futures• Trade on an organized exchange• Futures contracts are standardized with

regard to the following– The asset on which you trade a futures

contract– The contract size– Delivery arrangements

• Daily price movement limits-limit up and limit down

• Position limits• Mark to Market on a daily basis

Corporate Use of Currency Corporate Use of Currency FuturesFutures

• Hedge open positions in foreign currencies by buying/selling currency futures

• Foreign currency cash inflows– Risk: domestic currency may appreciate – Strategy: sell foreign currency in the futures

market at the futures exchange rate (Short)

• Foreign currency cash outflows– Risk: domestic currency may depreciate– Strategy: buy foreign currency in the futures

market at the futures exchange rate (Long)

Forward ContractsForward Contracts• Agreement to buy or sell an asset at a

certain time in the future for a predetermined price

• Over-the-counter product that do not trade on any organized exchange

• Delivery date can be any date that is mutually convenient to both the parties to the contract

• Size can be customized • Not marked-to-market daily

Hedging and Speculation Hedging and Speculation using Forwardsusing Forwards

• Expect a currency to appreciate– Buy that currency forward (Long Position)

• Expect a currency to depreciate– Sell that currency forward (Sell Position)

• Profit/Loss in a long position: ST – K• Profit/Loss in a short position: K – ST

Where ST is the spot exchange rate at maturity and K is the forward exchange rate at which you buy/sell a currency forward.