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Lecture Multinational financial management - Topic 9: Currency forwards and futures

In this chapter, Students understand and can recall the costs and benefits of hedging, payoffs and profits of currency forwards and futures, difference between a forward and futures, how to speculate with forwards and futures contracts, how financial managers use forwards and futures to hedge fx risk, how futures are traded and margin calculated. | Topic #9: Currency forwards and futures L. Gattis The Pennsylvania State University 1 Finance 407: Multinational Financial Management Review Poll 2 What are the CIA profits from borrowing $100,000 and investing in AUS sovereign bonds? A. $513 B. $272 C. -$471 D.-$187 Currency 6-month Sovereign Yields(ann) 6-month LIBOR Yields (ann) Spot (direct quote) 6-month Forward USD 0.50% 1.5% AUS 5.00% 5.50% $1.0234 - 45 $1.0023 – 33 Learning Objectives 3 Students understand and can recall The costs and benefits of hedging Payoffs and profits of currency forwards and futures difference between a forward and futures How to speculate with forwards and futures contracts How financial managers use forwards and futures to hedge fx risk How futures are traded and margin calculated Currency Speculating: Trading Spots 4 Suppose you have inside information that the European Central Bank (ECB) will make a surprise announcement next week that they will raise short term interest rates– raising real interest | Topic #9: Currency forwards and futures L. Gattis The Pennsylvania State University 1 Finance 407: Multinational Financial Management Review Poll 2 What are the CIA profits from borrowing $100,000 and investing in AUS sovereign bonds? A. $513 B. $272 C. -$471 D.-$187 Currency 6-month Sovereign Yields(ann) 6-month LIBOR Yields (ann) Spot (direct quote) 6-month Forward USD 0.50% 1.5% AUS 5.00% 5.50% $1.0234 - 45 $1.0023 – 33 Learning Objectives 3 Students understand and can recall The costs and benefits of hedging Payoffs and profits of currency forwards and futures difference between a forward and futures How to speculate with forwards and futures contracts How financial managers use forwards and futures to hedge fx risk How futures are traded and margin calculated Currency Speculating: Trading Spots 4 Suppose you have inside information that the European Central Bank (ECB) will make a surprise announcement next week that they will raise short term interest rates– raising real interest rates. You expect the exchange rate to increase from the current spot rate ($1.4786-7) to $1.55 in one week. You have $5,000 to spend. You can buy 3,381 euros in the spot market. ($5000*€(1/1.4787)/$= €3,381) What is your profit if the euro goes to $1.55 or 1.40? $1.55: €3,381*(1.55-1.4787)=$241 $1.40: €3,381*(1.40-1.4787)=-$266 You could also “buy” a 1-week forward contract to speculate. Forwards 5 Forward contracts are negotiated between parties (OTC), the terms include Currency pair, Quantity, Price, Delivery date and location Physical delivery or cash settlement Physical: Deliver or Take Delivery of Physical Currency. The majority of currency forwards are physical settlement. Cash Settlement: USD payment based on final spot exchange rate. Positions: Long (buyer of fx, takes delivery, gains if price increases, also called buyer) and Short party (seller of fx, make delivery, gains if price falls, also called seller) Usually requires no upfront payment if between two highly rated .