Post on 13-Jan-2016
description
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-1
Chapter 18Chapter 18 Currency Futures and Futures MarketsCurrency Futures and Futures Markets
18.1 The Evolution of Financial Futures Exchanges
18.2 The Operation of Futures Markets
18.3 Futures Contracts
18.4 Forward versus Futures Market Hedges
18.5 Futures Hedges Using Cross Exchange Rates
18.6 Hedging with Currency Futures
18.7 Summary
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-2
Currency futures contractsCurrency futures contracts
Forward contracts and default risk
» Forward contracts are a pure credit instrument; one party always has an incentive to default.
The futures contract solution
» An exchange clearinghouse takes one side of every transaction
» Futures contracts are marked-to-market on a daily basis
» Initial and maintenance margins are required on futures contracts
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-3
Financial futures exchangesFinancial futures exchanges
The International Monetary Market (IMM)
(a subsidiary of the Chicago Mercantile Exchange)
The Philadelphia Board of Trade (PBOT)
(a subsidiary of the Philadelphia Stock Exchange)
The Bolsa Mercadorias & de Futuros (BM&F) in Brazil
The London International Financial Futures Exchange (LIFFE)
The Marché à Terme des Instruments Financiers (MATIF)
The Singapore International Monetary Exchange (SIMEX)
The Tokyo International Financial Futures Exchange (TIFFE)
(a subsidiary of the Tokyo Stock Exchange)
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-4
A comparison of currency forwardA comparison of currency forwardand CME futures contractsand CME futures contracts
Forwards Futures
Location Interbank Exchange floor
Maturity Negotiated 3rd week of the month
Amount Negotiated Standard contract (e.g. ¥12,500,000 )
Fees Bid-ask Commissions (e.g. $30 per contract)
Counterparty Bank CME Clearinghouse
Collateral Negotiated Margin account
Settlement At maturity Most are settled early
Trading hours 24 hours During exchange hours
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-5
Been there, done that...Been there, done that...
Futures contracts are similar to forward contracts
» Futures contracts are like a bundle of consecutive one-day forward contracts
» Daily settlement is the biggest difference between a forward and a futures contract.
Futures and forward contracts are nearly identical in their ability to hedge currency risk
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-6
Hedging with forwards and futuresHedging with forwards and futures
Currency forward contracts can provide a perfect hedge when the size and the timing of a foreign currency transaction are known.
Exchange-traded futures contracts come in only a few currencies, contract sizes, and maturity dates, and hence may not provide a perfect hedge against transaction exposure to foreign currency risk.
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-7
The growth of exchange-traded derivativesThe growth of exchange-traded derivatives
Source: Futures Industry Association (1995 figures are estimates)
Millions of contracts traded
0
500
1,000
1,500
2,000
2,500
1990 1991 1992 1993 1994 1995 1996 1997 1998
Options
Futures
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-8
Spot and futures price convergenceSpot and futures price convergence
Forward and futures prices are determined by IRP:
Futt,Td/f = Ft,T
d/f = Std/f [(1+id)/(1+if)]Tt
T
Forwardpremium
FutTd/f = ST
d/f
Fut0d/f
S0d/f
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-9
Maturity mismatches and basis riskMaturity mismatches and basis risk
If there is a maturity mismatch, futures contracts may not provide a perfect hedge.
The difference in interest rates (idif) is called the basis.
» The basis determines the relation of futures prices to spot prices through interest rate parity.
» The risk of change in the relation between futures and spot prices is called basis risk.
» When there is a maturity mismatch, basis risk makes a futures hedge slightly riskier than a forward hedge.
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-10
Maturity mismatches and the delta-hedgeMaturity mismatches and the delta-hedge
A delta-hedge: std/f = + futt
d/f + et
std/f = percentage changes in spot exchange rates
futtd/f = percentage changes in futures prices
The hedge ratio can be used to minimize the variance of the hedged position:
NFut* = (Amount in futures contracts)/(Amount exposed)
=
Hedge quality is measured by (s,fut )2
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-11
Maturity mismatches and the delta-hedge:Maturity mismatches and the delta-hedge:An exampleAn example
You work in the United States and need to hedge a €100 million obligation due on June 3. It is now January 15.
» The spot exchange rate is S0$/€ = $1.10/€.
» The CME trades a euro futures contract expiring on June 16 with a contract size of €100,000.
» Based on the regression st$/€ = + futt
$/€ + et ,
you estimate = 1.020. The r-square is 0.95. » How many CME futures contracts should you buy
to minimize the risk of your hedged position?
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-12
June 18June 3January 15
-€100 million
underlying obligation
Futures expiration date following the
cash flow
Maturity mismatches and the delta-hedge:Maturity mismatches and the delta-hedge:An exampleAn example
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-13
Maturity mismatches and the delta-hedge:Maturity mismatches and the delta-hedge:SolutionSolution
The optimal hedge ratio for this delta-hedge is given by
NFut* = (amt in futures)/(amt exposed) = -
(amt in futures) = (-)(amt exposed)
= (-1.020)(€100 million) = €102 million
so buy
(€102 million) / (€100,000/contract)
= 1,020 contracts
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-14
Currency mismatches and the cross-hedgeCurrency mismatches and the cross-hedge
If there is a currency mismatch but not a maturity mismatch, a futures cross-hedge can be used.
A cross-hedge: std/f1 = + st
d/f2 + et
std/f1 = percentage changes in the currency (f1)
of the underlying exposure
std/f2 = percentage changes in the currency (f2)
of the futures contract
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-15
The delta-cross-hedgeThe delta-cross-hedge
If there is a currency mismatch and a maturity mismatch, a delta-cross-hedge can be used.
A delta-cross-hedge: std/f1 = + futt
d/f2 + et
std/f1 = percentage changes in the currency (f1)
of the underlying exposure
futtd/f2 = percentage changes in the value of the
futures contract on currency f2
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 18-16
A classification of futures hedgesA classification of futures hedges
Currency
Maturity
Exact match
Exactmatch
Mismatch
Mismatch
Cross-hedge(st
d/f2 = + std/f1 + e)
Delta-cross-hedge(st
d/f2 = + futtd/f1 + e)
Perfect hedge(st
d/f = + std/f + e)
(so that &
Delta-hedge(st
d/f = + futtd/f + e)
Hedge(hedge ratio estimation)