International Corporate Finance: Value Creation with Currency Derivatives in Global Capital Markets, + Website

CHAPTER 7

Currency Futures, Options, and Swaps

A dog, used to eating eggs, saw an oyster; and opening his mouth to its widest extent, swallowed it down with the utmost relish, supposing it to be an egg. Soon afterward suffering great pain in his stomach, he said, “I deserve all this torment, for my folly in thinking that everything round must be an egg”

The Fables of Aesop

Forward exchange contracts had been available for decades, but it was not until the breakdown of the Bretton Woods system of fixed exchange rates and the resulting heightened volatility in currency prices that new foreign exchange (FX or forex) risk management products started to appear. Futures contracts on foreign exchange were first introduced in May 1972, when the International Monetary Market (IMM) of the Chicago Mercantile Exchange (CME) began trading contracts on the British pound, Canadian dollar, Deutsche mark, Japanese yen, and Swiss franc. Currency options started to trade in the over-the-counter market in the early 1970s, but standardized contracts were not introduced until 1987 on the Philadelphia Stock Exchange Market.

By reading this chapter you will understand:

• How financial derivatives came into being.
• What currency futures contracts are and how they differ from currency forward contracts.
• How counterparty risk in futures contracts is mitigated.
• What currency options are and how they differ from futures and forwards.
• How currency options are priced.
• How the put-call parity binds the option ...