INTERNATIONAL FINANCE

1 Dr. Nathan (Thanh Nguyen)

 Chapter 3.
Currency derivatives
 LEARNING OUTCOMES

 Understand the characteristics of the forward

market, future markets and options markets.

 Use forward, future and option contracts to

hedge or speculate
CURRENCY DERIVATIVES

FORWARD MARKET

CURRENCY FUTURES
MARKET
3.

CURRENCY OPTIONS
MARKET
 1. FORWARD MARKET

The forward market facilitates the trading of forward

contracts on currencies. A forward contract is an
agreement between a corporation and a 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
 1. FORWARD MARKET

 The parties are bound by the contract and are

responsible for fulfilling their contractual
obligations
 The most common forward contracts are for 30, 60,
90, 180, and 360 days, although other periods
(including longer periods) are available
1. FORWARD MARKET

Forward Rate:
- Used to to lock in exchange rate at which
they can buy or sell foreign currencies.
- It depends on:
• Spot rate

▪ Period

• Interest rate of involving currency

1. FORWARD MARKET

Forward Rate:
 Formula to calculate bid rate (tỷ giá MUA):

 R1 − R 2 
Fb = Sb + Sb   n
 N 
Fb: Forward Bid exchange rate
Sb: Spot Bid exchange rate
n: period
N: number of a period
R1: deposit interest rate of quote currency
R2: loan interest rate of commodity currency
1. FORWARD MARKET
Forward Rate:
 Formula to calculate ask rate (tỷ giá BÁN): :

 R1 − R 2 
Fa = Sa + Sa   n
Trong đó:  N 
Fb: Forward Ask exchange rate
Sb: Spot Ask exchange rate
n: period
N: number of a period
R1: loan interest rate of quote currency
R2: deposit interest rate of commodity currency
 1. FORWARD MARKET
Example
 Customer C wants to sell 20,000 EUR from an export
contract in next three months,
 Customer D needs to buy 25,000 EUR to pay for next 6
months
 Spot rate EUR / VND is equal to 25,940 / 26,018
 Interest rates for EUR and VND as follows:

Currency 3 months period 6 months period

Deposit Loan deposit Loan
EUR (% per year) 3.25 4.25 3.28 4.32
VND (% per year) 7.2 9 7.8 10.2

1. Determine the 3-month forward buying rate to offer customers C

2. Determine the 6-month forward ask rate to offer customers D

1. FORWARD MARKET

 Application of Forward market:

Hedging:
Payable in import operation

Receivables in export operation

Investment in foreign currency

Loan in foreign currency

1. THỊ TRƯỜNG KỲ HẠN

 Application of Forward market:

 Speculation
If the trader expects a strong appreciation
in the future.
 → speculation by buying that currency term.
 If the trader expects a strong devaluation in
the future.
 → speculation by selling the term of that
currency.
2. CURRENCY FUTURES MARKET

 Concept:

Currency futures contracts are contracts

specifying a standard volume of a particular
currency to be exchanged on a specific settlement
date.
 2. CURRENCY FUTURES MARKET

Future contracts were created to overcome

Why do we have
3 issues of forward contracts:
future contract?
 Difficulties in finding transaction
partners.
 Partner risk does not perform the
contract
 Difficult to remove contractual
obligations.
2. CURRENCY FUTURES MARKET

 Feature:

 Standardized contract: contract size, price,

delivery month, delivery date …

 Traded currencies on the floor

 Can remove contract obligations easily

2. CURRENCY FUTURES MARKET

Trading mechanism and payment process

 Margin Mechanism

 Daily payment mode

 Mechanism of Final settlement

 MARGIN

 Initial margin: Amount of money need to have to

open future market.
 Variation margin :

 Minimum amount of money need to maintain on

the following days.
 Minimum amount of money before investor
offered margin call
 DAILY PAYMENT MODE

 Example

BUY EUR FUTURES CONTRACT

Date 10/11/2006
Delivery month 06/2007
Exchange rate 1.253 EUR/USD
Contract scale EUR 125,000
Initial margin 1.5% contract value

Variation margin USD 2,000

 DAILY PAYMENT MODE

Deposit/ Balance at
Settlement Contract
Date Profit/loss Withdrawa the end of
price value
l amount the day

Sign
1.2530 156,625 2349.375 2349.375
contract
10/11/2006 1.2535 156,687.5 62.5 2411.875
13/11/2006 1.2537 156,712.5 25 2436.875
14/11/2006 1.2547 156,837.5 125 2561.875
15/11/2006 1.2540 156,750 (87.5) 2474.375
16/11/2006 1.2538 156,725 (25) 2449.375
17/11/2006 1.2550 156,875 150 2599.375
20/11/2006 1.2545 156,812.5 (62.5) (2536.875)
 DAILY PAYMENT MODE
Buy GBP futures contracts
Date 1/1/2010
Delivery month 09/2010
Exchange rate 1.5088 GBP/USD
Contract scale GBP 62,500
Initial margin USD 1,755
Variation margin USD 1,300
 DAILY PAYMENT MODE

Account
Deposit/
Payment Contract balance at
Date Loss/ profit withdraw
price value the end of
amount
the day
Sign
1.5088
contract

01/01/2010 1.5076
02/01/2010 1.5045
03/01/2010 1.5010
04/01/2010 1.5006
05/01/2010 1.5050
08/01/2010 1.5072
09/01/2010 1.5091
 MECHANISM OF FINAL SETTLEMENT
Case 1: Future contracts are not maintained
until maturity.

 If a person is in long position (buyer) of a

futures contract, he can close this position by
reselling the contract in the market.

 If a person is in a short position (seller) of a

futures contract, he can close this position by
buying a contract in the market.
 MECHANISM OF FINAL SETTLEMENT

Case 2: Future contracts are maintained until

maturity:
 The buyer will resell the future contract to the
clearing company, the amount of money to buy will
be bought in the spot market.
 The seller will repurchase the futures contract from
the clearing company, the money will be sold on the
spot market.
2. CURRENCY FUTURES MARKET

Application:

 Speculation

 Hedging
3. CURRENCY OPTIONS MARKET

 Concept

 Currency options provide the right to

purchase or sell currencies at specified
prices.
3. CURRENCY OPTIONS MARKET

▪ Classification

Currency
option

Currency Currency
call option put option
 3. CURRENCY OPTIONS MARKET

 Classification
Currency call option Quyền chọn mua

Buyer Seller
Bên mua Bên bán

• Obligation: Pay option • Right: Receive option

fees. fees.
• Right: Buy a certain • Obligation: Sell a certain
currency at a specified currency at a specified
price price, if the buyer
exercises his rights
3. CURRENCY OPTIONS MARKET

 Classification
Currency put option Quyền chọn bán

Bên mua Bên bán

Buyer Seller

• Obligation: Pay option • Right: Receive option

fees. fees.
• Right: Sell a certain • Obligation: Buy a certain
currency at a specified currency at the price
price. determined if the buyer
exercises his right
3. CURRENCY OPTIONS MARKET

European and American style options:

 European style: Only allow the option to

be exercised at the time of maturity.

 American style: Allows the option to be

exercised at any time until the contract is
due.
 3. CURRENCY OPTIONS MARKET
30

 Option rate
Call option contract
Call option rate is applied to buy foreign currency
 Call option rate is smaller than spot rate =>
apply Call option
 Call option rate is larger than spot rate => not
apply Call option
 3. CURRENCY OPTIONS MARKET

 In call option contract:

❖ Net profit receiving in buy call option

Net profit = Spot rate – Premium paid for call option –

Purchase price

Net profit receiving in sell call option

Net profit = Premium paid for call option - Spot rate +

Purchase price
 3. CURRENCY OPTIONS MARKET

 Option rate

Put option contract (chọn bán):

Put option rate is applied to sell foreign currency

 Put option rate is smaller than spot rate =>

not apply Put option

 Put option rate is larger than spot rate =>

apply Put option
 3. CURRENCY OPTIONS MARKET

 In put option contract:

❖ Net profit receiving in buy put option (mua quyền chọn

bán)

Net profit = Purchase price (giá thực hiện)- Spot rate -

Premium paid for put option

❖ Net profit receiving in sell put option (bán quyền chọn

bán)

Net profit = Premium paid for put option + Spot rate -

Purchase price
 3. CURRENCY OPTIONS MARKET

 Information about USD/VND option price as follow:

Content Call option Put option

Value of the contract 100,000 USD 100,000 USD

Purchase price 20,830 20,850

Period 3 months 3 months

Style option US US

Premium 10 dong /USD 20 dong /USD

 3. CURRENCY OPTIONS MARKET
On December 5th, customer A bought a call option and
customer B bought an put option.

1. Calculate the premium that the bank earned from selling the
option contracts to customers A and B?

2. How does the exchange rate of USD / VND in the market

change that lead customers A and B will exercise options to
earned profit?

3. Assuming that the USD / VND exchange rate is 20,890 on

the due date, how much profit or loss will customers get?