Currency futures

Currency futures

Currency futures are a tool for hedging foreign exchange risk.

Futures contracts are standard sized, traded hedging instruments. The aim of a currency futures contract is to fix an exchange rate at some future date.

Futures hedging calculations

Step 1: Set up the hedge by addressing 3 key questions:

  • Do we initially buy or sell futures?
  • How many contracts?
  • Which expiry date should be chosen?

Step 2: Contact the exchange. Pay the initial margin. Then wait until the transaction / settlement date.

Step 3: Calculate profit or loss in the futures market by closing out the futures contracts, and calculate the value of the transaction using the spot rate on the transaction date.

Setting up the hedge

Buying or selling futures and the currency of the contract

  • A key issue with currency futures is to establish the currency of the contract or CC. For example if the CC is $ and your transaction involves buying $, you should buy futures now to set up the hedge.

In exam questions the contract size will always be given to you, quoted in terms of the CC. For example,

The CC is the currency in which the contract size is quoted.

Expiry date

We assume that the contracts mature or expire at the end of March, June, September and December. It is normal to choose the first contract to expiry after the conversion date.

The range of available futures is limited and includes: $/£, $/Y, $/SFR, $/A$, $/C$ and $/€. Therefore if you are asked to give a hedge strategy for a "minor" currency you should not recommend a futures contract.

Created at 9/12/2012 3:07 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London
Last modified at 11/13/2012 3:26 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London

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Currency risk;foreign exchange risk

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