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    Forward Market

    Uploaded by

    samihaz02
    The forward market facilitates trading of forward contracts to exchange currencies at a specified future date at a fixed exchange rate. Forward contracts are agreed between corporations and banks, and are often valued at $1 million or more. They allow multinational corporations to lock in future exchange rates in anticipation of currency needs or receipts. Forward rates include a premium or discount relative to the current spot rate depending on whether the home or foreign interest rate is higher. Currency futures contracts are traded on exchanges and involve standardized contract sizes and settlement dates. They are used by multinational corporations and speculators to hedge currency risk or profit from exchange rate movements.

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    © All Rights Reserved
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    Forward Market

    Uploaded by

    samihaz02
    323 views25 pages
    The forward market facilitates trading of forward contracts to exchange currencies at a specified future date at a fixed exchange rate. Forward contracts are agreed between corporations and banks, and are often valued at $1 million or more. They allow multinational corporations to lock in future exchange rates in anticipation of currency needs or receipts. Forward rates include a premium or discount relative to the current spot rate depending on whether the home or foreign interest rate is higher. Currency futures contracts are traded on exchanges and involve standardized contract sizes and settlement dates. They are used by multinational corporations and speculators to hedge currency risk or profit from exchange rate movements.

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    finance

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    The forward market facilitates trading of forward contracts to exchange currencies at a specified future date at a fixed exchange rate. Forward contracts are agreed between corporations and banks, and are often valued at $1 million or more. They allow multinational corporations to lock in future exchange rates in anticipation of currency needs or receipts. Forward rates include a premium or discount relative to the current spot rate depending on whether the home or foreign interest rate is higher. Currency futures contracts are traded on exchanges and involve standardized contract sizes and settlement dates. They are used by multinational corporations and speculators to hedge currency risk or profit from exchange rate movements.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    323 views25 pages

    Forward Market

    Uploaded by

    samihaz02
    The forward market facilitates trading of forward contracts to exchange currencies at a specified future date at a fixed exchange rate. Forward contracts are agreed between corporations and banks, and are often valued at $1 million or more. They allow multinational corporations to lock in future exchange rates in anticipation of currency needs or receipts. Forward rates include a premium or discount relative to the current spot rate depending on whether the home or foreign interest rate is higher. Currency futures contracts are traded on exchanges and involve standardized contract sizes and settlement dates. They are used by multinational corporations and speculators to hedge currency risk or profit from exchange rate movements.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 25
    At a glance
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    The key takeaways are that forward contracts allow multinational corporations to lock in exchange rates for future currency needs or receipts, and are often valued at $1 million or more. Forward rates may contain a premium or discount compared to the spot rate depending on interest rate differentials.

    Forward contracts are customized agreements between corporations and banks to exchange currencies at a specified forward rate on a future date. They are often valued at $1 million or more and mainly used by large corporations rather than consumers or small businesses.

    Forward rates are different from spot rates, as they are influenced not only by the current spot rate but also by the interest rate differential between the two currencies over the duration of the contract. A forward rate higher than the spot rate indicates a premium, while a lower rate indicates a discount.

    Forward Market

    The forward market facilitates the trading


    of forward contracts on currencies.
    A forward contract is an agreement
    between a corporation and a financial
    institution (commercial bank) to exchange
    a specified amount of a currency at a
    specified exchange rate (called the
    forward rate) on a specified date in the
    future.
    A5 - 1

    Forward Market
    When MNCs anticipate future need or
    future receipt of a foreign currency, they
    can set up forward contracts to lock in the
    exchange rate.
    Forward contracts are often valued at $1
    million or more, and are not normally used
    by consumers or small firms.

    A5 - 2

    Forward Market
    As with the case of spot rates, there is a
    bid/ask spread on forward rates.
    Forward rates may also contain a premium
    or discount.
    If the forward rate exceeds the existing
    spot rate, it contains a premium.
    If the forward rate is less than the existing
    spot rate, it contains a discount.

    A5 - 3

    Forward Market
    annualized forward premium/discount
    forward rate spot rate 360
    spot rate n
    where n is the number of days to maturity
    Example: Suppose spot rate = $1.681,
    90-day forward rate =
    $1.677.
    =

    $1.677 $1.681 x 360 = 0.95%


    A5 - 4

    Forward Foreign Exchange


    Contract
    Definition:
    An agreement to exchange one
    currency for another, where

    The exchange rate is fixed on the day of the


    contract, but

    The actual exchange takes place on a predetermined date in the future

    A5 - 5

    Characteristics and Features of


    FX Forwards
    Available daily in major currencies in 30-, 90-,
    and 180-day maturities

    Forwards are entered into over the counter


    Deliverable forwards: face amount of currency
    is exchanged on settlement date

    Non-deliverable forwards: only the gain or loss


    is exchanged
    6

    A5 - 6

    Characteristics and Features of


    FX Forwards
    Contract terms specify:

    forward exchange rate


    term
    amount
    value date (the day the forward contract expires)
    locations for payment and delivery.

    The date on which the currency is actually


    exchanged, the settlement date, is generally
    two days after the value date of the contract.
    7

    A5 - 7

    Characteristics and Features of


    FX Forwards
    Forward Exchange Rates: The Iron-Clad Law
    Forward exchange rates are different from spot rates, but
    they are not a prediction of what the spot rate will be
    when the deal settles!
    The difference between the
    forward exchange rate and the spot exchange rate
    is the interest differential
    between the two currencies

    A5 - 8

    Example 1: Hedging
    With an FX Forward
    Hedged Item
    Company must pay EUR
    1,000,000 to a eurozone
    supplier in 3 months
    Spot rate HRK/EUR: 7.3000.
    Treasurer believes HRK will
    depreciate during next 3
    months
    Exposure to FX risk:
    What will be exchange rate
    HRK/EUR in three
    months??

    Hedging Instrument
    Bank buys 1,000,000 EUR
    forward at forward rate of
    7.3750

    FX risk: Company is
    protected against large
    adverse FX rate
    movements
    If FX rate is unfavorable in 3
    months (ie, > 7.3750),
    Company pays just
    A5 - 9

    Example 1: Hedging
    With an FX Forward

    Hedged Item
    Company must pay EUR
    1,000,000 to a eurozone
    supplier in 3 months
    Spot rate HRK/EUR: 7.3000.
    Treasurer believes HRK will
    depreciate during next 3
    months

    Advantages of Hedge:
    Company knows its costs and
    can plan its finances
    accordingly
    Cost of the hedge is zero - No money is exchanged at
    inception of the forward FX
    agreement

    Hedging Instrument
    Bank buys 1,000,000 EUR
    forward at forward rate of
    7.3750

    Disadvantage of Hedge:
    Company is still exposed to FX
    risk if the HRK/EUR spot rate
    is less than 7.3750 in 3
    months
    Effect of hedge is same as
    buying EUR today and
    holding in an interestbearing account
    (Forward FX agreement is
    NOT a simple speculation)

    A5 - 10

    Example 1: Hedging
    With an FX Forward
    Unhedged Company
    If in 3 months, spot
    rate is 7.4500

    Effect of Hedging
    Hedged Company has
    already bought EUR
    forward

    Unhedged Company
    must pay:
    7.45 x 1,000,000 =
    HRK 7,450,000

    Hedged Company will pay:


    7.375 x 1,000,000 = HRK
    7,375,000

    Money saved by
    hedging: 7,450,000
    7,375,000 =
    HRK 75,000

    A5 - 11

    Example 2: Deriving the


    Forward Exchange Rate
    The spot rate HRK/EUR is 7.3000
    A bank today sells a 3-month HRK/EUR
    forward to a company for a forward
    exchange rate of 7.3371

    How did the bank compute the forward


    rate?
    12

    A5 - 12

    Example 2: Deriving the


    Forward Exchange Rate
    Three month interest rates are:

    1% on the euro
    3% on the kuna

    A company with EUR 1 million and a need for HRK in


    three months should be indifferent, financially
    speaking, as to whether it:

    Invests the EUR 1 million for 3 months at 1% and converts the


    euros (plus interest) into HRK at the end of this time, or
    Sells the EUR 1 million spot for HRK, and invests the HRK at
    3% for 3 months

    13

    A5 - 13

    Example 2: Deriving the


    Forward Exchange Rate
    OPTION 1

    OPTION 2

    Invest EUR 1 million at 1%


    for 3 months (91 days)

    Sell EUR 1 million spot at 7.30


    Buy HRK 7.3 million
    Invest HRK for 3 months at 3%

    Interest earned EUR


    2,493.15

    Interest earned HRK


    55,358.33
    (7.3 million x 3% x 91/360)

    Value after 3 months


    EUR 1,002,493

    Value after 3 months


    HRK 7,355,358

    Forward Exchange Rate: 7.3371


    A5 - 14

    Forward Market
    The forward premium/discount reflects the
    difference between the home interest rate
    and the foreign interest rate, so as to
    prevent arbitrage.

    A5 - 15

    Forward Market
    A non-deliverable forward contract (NDF)
    is a forward contract whereby there is no
    actual exchange of currencies. Instead, a
    net payment is made by one party to the
    other based on the contracted rate and the
    market rate on the day of settlement.
    Although NDFs do not involve actual
    delivery, they can effectively hedge
    expected foreign currency cash flows.
    A5 - 16

    Currency Futures Market


    Currency futures contracts specify a
    standard volume of a particular currency to
    be exchanged on a specific settlement
    date, typically the third Wednesdays in
    March, June, September, and December.
    They are used by MNCs to hedge their
    currency positions, and by speculators
    who hope to capitalize on their
    expectations of exchange rate movements.
    A5 - 17

    Currency Futures Market


    The contracts can be traded by firms or
    individuals through brokers on the trading
    floor of an exchange (e.g. Chicago
    Mercantile Exchange), on automated
    trading systems (e.g. GLOBEX), or overthe-counter.
    Participants in the currency futures
    market need to establish and maintain a
    margin when they take a position.
    A5 - 18

    Currency Futures Market


    Forward Markets Futures Markets
    Contract size Customized. Standardized.
    Delivery date Customized. Standardized.
    Participants Banks, brokers, Banks, brokers,
    MNCs. Public MNCs. Qualified
    speculation not public speculation
    encouraged. encouraged.
    Security Compensating Small security
    deposit bank balances ordeposit required.
    credit lines needed.

    A5 - 19

    Currency Futures Market


    Clearing
    operation

    Forward Markets Futures Markets


    Handled by
    Handled by
    individual banks
    exchange
    & brokers.
    clearinghouse.
    Daily

    settlements
    to market
    Marketplace Worldwide Central exchange
    prices.
    telephone floor with global
    network.communications.

    A5 - 20

    Currency Futures Market


    Regulation

    Forward Markets
    Self-regulating.

    Futures Markets
    Commodity
    Futures Trading
    Commission,
    National

    Futures
    Association.
    Liquidation Mostly settled by Mostly settled
    by
    actual delivery. offset.
    Transaction Banks bid/ask Negotiated
    Costsspread. brokerage fees.

    A5 - 21

    Currency Futures Market


    Normally, the price of a currency futures
    contract is similar to the forward rate for a
    given currency and settlement date, but
    differs from the spot rate when the interest
    rates on the two currencies differ.
    These relationships are enforced by the
    potential arbitrage activities that would
    occur otherwise.

    A5 - 22

    Currency Futures Market


    Currency futures contracts have no credit
    risk since they are guaranteed by the
    exchange clearinghouse.
    To minimize its risk in such a guarantee,
    the exchange imposes margin
    requirements to cover fluctuations in the
    value of the contracts.

    A5 - 23

    Currency Futures Market


    Speculators often sell currency futures when they
    expect the underlying currency to depreciate, and
    vice versa.
    Currency futures may be purchased by MNCs to
    hedge foreign currency payables, or sold to
    hedge receivables.
    Holders of futures contracts can close out their
    positions by selling similar futures contracts.
    Sellers may also close out their positions by
    purchasing similar contracts
    A5 - 24

    Currency Futures Market


    Most currency futures contracts are
    closed out before their settlement dates.
    Brokers who fulfill orders to buy or sell
    futures contracts earn a transaction or
    brokerage fee in the form of the bid/ask
    spread.

    A5 - 25

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