Foreign Exchange Market and Currency

1885 Words Sep 14th, 2013 8 Pages
(a) Using a well articulated example show how currency options can be used to manage currency risk. Graphically illustrate the payoffs of the selected case.

A. CURRENCY RISK

Currency risk is the type of risk that is derived changes in the apparent value of currencies. These changes incur a loss when the profit or the dividends of the investment are calculated from the local currency into the U.S. Dollar.
“For example, suppose that a U.S.-based investor purchases a German stock for 100 euros. While holding this bond, the euro exchange rate falls from 1.5 to 1.3 euros per U.S. dollar. When the investor sells the bonds, he or she will realize a 13% loss upon conversion of the profits from euros to U.S. dollars.”
(
…show more content…
It saves the owner from unpredicted fluctuations in the currency values. This tool is used worldwide in many different industries like the stock market and shares holdings companies. This also helps maintaining the market balance to avoid other unanticipated problems in the market.

Currency options are flexible in nature as well and most of its work is over the counter and regulated properly. Moreover, it is lightly handled therefore easy to carry out.
A good example of options being used over forwards is because of uncertain variations.
“. However, if we truly believe in the expectations theory we may choose to do nothing, for example an exporter facing a weak forward rate would not use a forward or an option but may choose to remain unhedged.”( http://www.cimaglobal.com)

(b) Use Chicago mercantile exchange website to review the prevailing prices of currency futures contracts. If you purchase an Australian dollar with the closest settlement data what is the futures price?(clearly indicate the date you have accessed the information). Is today’s price different from that of the day before?. How can you explain the change in the futures price?. Given that a contract is based on 100,000 Australian dollars, what is the USD amount you will need at the settlement date to fulfill the contract?

A. “Currency futures, also called forex futures or foreign exchange futures, are exchange-traded futures contracts to buy or sell a specified amount of a
Open Document