Multinational-Finance-IM-(8)

Chapter8ForeignCurrencyDerivativesandSwapsQuestions1.OptionsversusFutures.Explainthedifferencebetweenforeigncurrencyoptionsandfuturesandwheneithermightbemostappropriatelyused.Aforeigncurrencyoptionisacontractthatgivestheoptionpurchaser(thebuyer)theright,butnottheobligation,tobuyorsellagivenamountofforeignexchangeatafixedpriceperunitforaspecifiedtimeperiod(untilthematuritydate).Aforeigncurrencyfuturescontractcallsforfuturedeliveryofastandardamountofforeignexchangeatafixedtime,place,andprice.Theessenceofthedifferenceisthatanoptionleavesthebuyerwiththechoiceofexercisingornotexercising.Thefuturerequiresamandatorydelivery.2.TradingLocationforFutures.ChecktheWallStreetJournaltofindwhereintheUnitedStatesforeignexchangefuturecontractsaretraded.TheWallStreetJournalreportsonforeignexchangefuturestradingforChicagoMercantileExchange(CME).3.FuturesTerminology.Explainthemeaningandprobablesignificanceforinternationalbusinessofthefollowingcontractspecifications:Specific-sizedcontract.Tradingmaybeconductedonlyinpre-establishedmultiplesofcurrencyunits.Thismeansthatafirmwishingtohedgesomeaspectofitsforeignexchangeriskmaynotbeabletomatchthecontractsizewiththesizeoftherisk.Standardmethodofstatingexchangerates.Ratesarestatedin“Americanterms,”meaningtheU.S.dollarvalueoftheforeigncurrency,ratherthaninthemoregenerallyaccepted“Europeanterms,”meaningtheforeigncurrencypriceofaU.S.dollar.Thishasnoconceptualsignificance,althoughfinancialmanagersusedtoviewingexposureinEuropeantermswillfinditnecessarytoconverttoreciprocals.Standardmaturitydate.Allcontractsmatureatapre-establisheddate,beingonthethirdWednesdayofeightspecifiedmonths.Thismeansthatafirmwishingtouseforeignexchangefuturestocoverexchangeriskmaynotbeabletomatchthecontractmaturitywiththeriskmaturity.32Moffett/Stonehill/Eiteman•FundamentalsofMultinationalFinance,FourthEdition©2012PearsonEducation,Inc.PublishingasPrenticeHallCollateralandmaintenancemargins.Oneofthedefiningcharacteristicsoffuturesistherequirementthatthepurchaserdepositsasumasaninitialmarginorcollateral.Thisrequirementissimilartorequiringaperformancebond,anditcanbemetbyaletterofcreditfromabank,Treasurybills,orcash.Inaddition,amaintenancemarginisrequired.Thevalueofthecontractismarked-to-marketdaily,andallchangesinvaluearepaidincashdaily.Marked-to-marketmeansthatthevalueofthecontractisrevaluedusingtheclosingpricefortheday.Theamounttobepaidiscalledthevariationmargin.Counterparty.Allfuturescontractsarewiththeclearinghouseoftheexchangewheretheyaretraded.Consequently,afirmorindividualengagedinbuyingorsellingfuturescontractsneednotworryaboutthecreditriskoftheopposite,orcounter,party.4.AFuturesTrade.Anewspapershowsthepricesbelowforthepreviousday’stradinginU.S.dollar-eurocurrencyfutures.Whatdothetermsshownindicate?Thisdatareportsthat29,763contracts,eachcontractbeingfor€125,000,weretradedforsettlementonthethirdWednesdayofthefollowingDecember.Thetotaleurovalueofallcontractstradedonthedayforwhichdataarereportedistheproductofthetwonumbers:29,763€125,000€3,720,375,000.Thehighestpriceduringthedayatwhicheurofuturestradedwas$0.9147/€.Thelowestpricewas$0.9098/€.Thefirsttradeofthedaywasat$0.9124/€andthelasttrade,called“settlement,”wasat$0.9136/€.Thisclosingpricewas0.0027abovethepreviousday’sclose,fromwhichonecandeterminethatonthepreviousdayeurocontractsclosedat$0.9136/€$0.0027/€$0.9109/€.Theclosing“settlement”priceisthepriceusedbyfuturesexchangestodeterminemargincalls.Openinterestisthesumofalllong(buyingfutures)andshort(sellingfutures)contractsoutstanding.5.PutsandCalls.WhatisthebasicdifferencebetweenaputonBritishpoundssterlingandacallonsterling?Aputonpoundssterlingisacontractgivingtheowner(buyer)theright,butnottheobligation,tosellpoundssterlingfordollarsattheexchangeratestatedintheput.Acallonpoundssterlingisacontractgivingtheowner(buyer)theright,butnottheobligation,tobuypoundssterlingfordollarsattheexchangeratestatedinthecall.6.CallContractElements.Youreadthatexchange-tradedAmericancalloptionsonpoundssterlinghavingastrikepriceof1.460andamaturityofnextMarcharenowquotedat3.67.Whatdoesthismeanifyouareapotentialbuyer?Ifyoubuysuchanoption,youhavetherighttoforcethewriter/selleroftheoptiontodeliverpoundssterlingtoyouandyouwillpay$1.460foreachpound.$1.460/£iscalledthe“strikeprice.”Youhavethisright(this“option”)untilnextMarch,andforthisrightyouwillpay3.67¢perpound.Theinformationprovidedtoyoudoesnottellyouthesizeofeachoptioncontract,whichyouwouldhaveChapter8ForeignCurrencyDerivativesandSwaps33©2012PearsonEducation,Inc.PublishingasPrenticeHalltoknowfromgeneralexperienceorfromaskingyourbroker.ThecontractsizeforpoundssterlingontheChicagoMercantileExchangeis£62,500percontract,meaningthattheoptionwillcostyou£62,500$0.0367$2,293.75.7.TheOptionCost.Whathappenstothepremiumyoupaidfortheaboveoptionintheeventyoudecidetolettheoptionexpireunexercised?Whathappenstothisamountintheeventyoudodecidetoexercisetheoption?Theamountyoupayfortheoptionisgoneforever,whetherornotyouexercisetheoption.Thisistheamountpaidtothewriter/selleroftheoption,whoundertakestheo