Futures FX Market

1. Futures FX Market Dr. J. D. Han King’s College University of Western Ontario

2. I. FX Futures 1. Rationales: 1) To overcome Lack of Liquidity of Forward Market, which is mostly O.T.C. -> Futures Market has Standardized Transactions, and is Standing Market -> Futures are Common men’s Forward Contract 2) To overcome the Credit/Default Risk -> Third Party Market, Performance Bonds(Margin), etc. 3) Leverage -> Leverage in futures trading means that the amount you need to deposit is small in comparison to the amount of product it will control.

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4. 3. History and Currents of the Futures Market: • Chicago Mercantile Exchange started FOREX Future Trading in 1972 • Daily average trading volume exceeds US $ 100 billion • Website of FX futures in CME http://www.cmegroup.com/trading/fx/

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6. Standardized Contract Size in CME • British Pound(GBP) 62,500 • Euro 125,000 • Swiss Franc 125,000 • Australian Dollar 100,000 • Canadian Dollar 100,000 • Chinese Yuan 1,000,000 • Japanese Yen 12,500,000 • Russian rubles 2,500,000 • Brazilian reals 100,000 • Mexican pesos 500,000 • Chinese Reminbi 1,000,000

7. 6. Operation of Futures Market: Daily Reconstructed/Settled Forward market • Margin Deposit (=performance bonds=Initial Deposit Requirement) • Buy (take long-position) if you expect/need the price of a currency to rise; Sell (take short-position) if you expect/need it to fall. • Futures settlement price changes every day • Profits or Losses are settled on a daily basis from a mandatory margin account -> “Marking to Market”

8. Numerical Example 1 • For example, John buys 10 September CME Euro FX Futures, at $1.2713/€. At the end of the day, the futures close at $1.2784/€. The change in price is $0.0071/€. As each contract is over €125,000, and he has 10 contracts, his daily profit is $8,875. This is paid to him immediately.

9. Numerical Example 2. • British Pound 625,000 pounds • Initial Margin = Performance Bonds -$ 2,900 for hedgers • Maintenance Margin = $ 2,900

10. Suppose you buy a unit at 1.4444 $ per Sterling Pound ($/Pound; note that they use the direct quotation) • Initial Margin Requirement by CME = $2,900 for a hedger • Suppose Actual Initial Margin Deposited = $3000 • Next day, the rate of GBP Futures falls to 1.4334 • You have lost 11 points or 0.0110 dollar per Sterling Pound. - For one unit has 62,500 pounds. - You have lost 0.0110 dollar x 62,500 pounds • Lost 687.5 dollars = Marking to the Market • Your Margin Balance = 3000 – 687.5 = $ 2313.5 • Maintenance Margin set by CME = $ 2900 • You have to refill by the Variation Margin Requirement to refill = $ 587.5

11. Numerical Example 2 • You are a Canadian exporter to U.S. and are to receive U.S. 1 mil in 3 months, that is, June 2010(t+1). • How would you do FX Hedging in the CME?

12. To start: Performance bond = U.S. $ 3300 for a hedger • Mindset: You have to put on the U.S. shoes-Act and think like you are a U.S. citizen for SU.S $./C$ • What to do? You are (buying/selling) Canadian Dollar Futures (CD) in CME, which will expire/deliver on March 2010. • How much? Each unit = C $100,000 So you buy 1/S = 1/0.82 =about 12 units of CD for $100,000 for the corresponding rate = 0.8159 at 10:25:30 AM CST 2/09/2009. Thus you pay 0.8159 x 100,000 x 12 = U.S. $ 978,900. You have to get it from Spot Market at the current Spot rate St.