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  3. Lecture International finance: An analytical approach (3/e): Chapter 9 - Imad A. Moosa

Lecture International finance: An analytical approach (3/e): Chapter 9 - Imad A. Moosa

Chapter 9 - Currency futures and swaps. In this chapter, the learning objectives are: To describe futures contracts and show how they circumvent the problems of forward contracts, to compare forward and futures markets, to describe swaps and introduce some terminology,... Chapter 9 Currency Futures and Swaps Objectives • To describe futures contracts and show how they circumvent the problems of forward contracts • To compare forward and futures markets • To describe swaps and introduce some term

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  1. Chapter 9 Currency Futures and Swaps
  2. Objectives • To describe futures contracts and show how they circumvent the problems of forward contracts • To compare forward and futures markets • To describe swaps and introduce some terminology Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-2
  3. Definition • Currency futures contracts represent an obligation of the seller to deliver a certain amount of a specified currency in the future at an exchange rate determined now Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-3
  4. Problems of Forward Contracts • Non-standard contract dimensions • Default risk • Lack of liquidity Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-4
  5. Using a forward contract JPY  C Forward contract A AUD  JPY  Goods  B Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-5
  6. Tendency to default on a forward contract USD 1 million  A tends to default A Forward rate = 1.80 B AUD 1.8 million USD 1  Spot rate = 1.90 AUD 1.9  million million C (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-6
  7. Tendency to default on a forward contract (cont.) USD 1 million B tends to default A Forward rate = 1.80 B AUD 1.8 million Spot rate = 1.70 USD 1  AUD 1.7  million million C (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-7
  8. Tendency to default on a forward contract (cont.) USD 1 million Forward rate = 1.80 Neither tends to default A B AUD 1.8 million AUD 1.8  AUD 1.8  Spot rate =  million million USD 1  Spot rate =  USD 1  1.80 1.80 million million C Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-8
  9. Unwinding a forward contract (a) Assigning the obligation to        another counterparty (D) JPY  Compensation  C AUD  D A Compensation (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-9
  10. Unwinding a forward contract (cont.) (b)  Cancelling the forward contract Cancellation fee C A (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-10
  11. Unwinding a forward contract (cont.) C JPY (c) Entering an offsetting         position with E AUD AUD A E JPY Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-11
  12. How futures contracts solve these problems • Standardised contract dimension • Default risk is controlled by the clearing corporation and some regulations • They are liquid Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-12
  13. The role of the clearing corporation in futures trading USD Clearing  USD corporation B A (exchange) AUD AUD Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-13
  14. A comparison of forward and futures markets • Market size • Market structure • Contract size • Traded currencies (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-14
  15. A comparison of forward and futures markets (cont.) • Cross rates • Exchange rate fluctuations • Maturity dates • Maturity lengths (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-15
  16. A comparison of forward and futures markets (cont.) • Credit risk • Cash flows • Hours of trading • Eligible dealers • Major users Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-16
  17. Futures exchanges • The Philadelphia Stock Exchange • The Chicago Mercantile Exchange • The Sydney Futures Exchange Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-17
  18. Definition of swaps • Currency and interest rate swaps involve the exchange of interest and foreign currency cash flows. They differ from swaps in the forward FX market (FX swaps) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-18
  19. Currency swaps • A currency swap is a transaction in which two counterparties exchange specific amounts of two different currencies at the outset and repay over time according to a predetermined rule Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-19
  20. Some features of currency swaps • They emerged in the 1980s with the World Bank playing a major role • They have evolved as a successor to parallel loans Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa Slides prepared by Afaf Moosa 9-20
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