Ways of expressing forward rates

In addition to the direct or indirect quotation, forward exchange rates can be expressed in one of three ways. First, the forward rate can be quoted as an outright rate — i.e. the actual forward rate of exchange.

Secondly, it can be quoted as forward exchange margins or points (also called swap rates). These latter are either discounts or premiums depending on the interest differentials between the home and foreign currency. If the foreign currency interest rate is higher than the home currency interest rate, the foreign currency will be at a forward discount to its spot rate. If, on the other hand, the foreign interest rate is below the home currency interest rate, the foreign currency will be at a forward premium to its spot value. The magnitude of the discount or premium is dependent upon the size of the differential in home and foreign interest rates and the time to maturity of the forward contract. Read more »

Posted: June 24th, 2008 under Currency Futures, Foreign Exchange Futures, Futures Market.
Comments: 5

The foreign exchange market is an interbank market, in that there is no designated market-place; instead transactions are conducted over the telecommunications system using telephones and computer screens. As a consequence, the foreign exchange (or FX) market is truly global, with all the major commercial banks around the world and the treasury departments of many companies participating. In addition, central banks enter the market in the execution of their monetary and exchange rate policies. There is also a system of brokers who act as intermediaries to supplement the direct contact between participants. As the trading day progresses, the centre of activity moves from one time zone to another, making it possible t trade internationally 24 hours a day.

The transactions in the FX market emanate from international trade, international investment, the hedging of exchange risks, the establishment of speculative positions or arbitraging between mispriced sections of what is a vast market. Read more »

Posted: June 24th, 2008 under Currency Futures, Foreign Exchange Futures, Future Exchange, Future Trading.
Comments: 4

The Black model should not be used for valuing American options on currency futures because it may be optimal to exercise the options early in the same way as it may be optimal to exercise options on the spot currency early. The binomial or the Barone-Adesi and Whaley models may be used for valuing those options.

The early exercise potential of American options on futures is different to that of options on the spot. Futures prices do not exhibit the discrete jumps that accompany spot market assets when the underlying spot asset makes discrete distributions. However, as the carry basis of the future converges to zero at delivery, the futures price converges to the spot price in an orderly manner. Read more »

Posted: June 22nd, 2008 under Currency Futures, Futures Options, Futures Prices, Swap Futures, investment.
Comments: 4

This section explains two of the many uses of options that rely upon the ability of the option buyer to abandon the option at no extra cost. The first is the purchase of options to insure against a fall in the value of a currency. The second is the hedging of the currency risk in a foreign currency tender.

Purchasing options as a form of insurance

If a US investment manager has strong expectations of a rise in the value of Sterling but wishes to insure against being totally wrong, slightly out-of-the money puts will provide the required insurance. Read more »

Posted: June 21st, 2008 under Commodities Futures, Equity Futures, Foreign Exchange Futures, Future Fund, Future Investing, Futures Options, Futures Prices, Futures Spreads, Futures Trading System, Managed Futures, Stock Futures, Stock Market Futures.
Comments: 5

The application of currency swaps

The parties enter into currency swaps in order to hedge the currency risk from their assets or liabilities. As the swap runs for many years without any change in the exchange rate used, the currency hedging is long term. It is this long-term hedging of currency risk that makes currency swaps complementary to, and not in competition with, the forward exchange market.

An example of the mechanics of a fixed for fixed currency swap is given on pp. 344-6, and below an example is given of how a fixed for floating currency swap can be used to hedge the currency risk in new borrowings. Read more »

Posted: June 7th, 2008 under Futures Market.
Comments: 6

Concern

The size of the markets can work against foreign investors in two ways. First, some securities and some countries may be illiquid. In such markets, any reasonably sized trades are sufficient to move the price. The price rises when one wants to buy and falls upon a sale. This is particularly painful because most foreign investors end up selling and buying around the same time.

The second concern with market size is inefficiency. Emerging markets are known to be inefficient, and prices can take several days to fully reflect new information. As a passive investor, you can lose money to more sophisticated investors who trade on the basis of the inefficiency. Read more »

Posted: February 14th, 2008 under Commodities Futures, Future Investing, Future Management.
Comments: 6

Costs and Taxes

Concern

The cost of investing internationally is significantly higher than investing domestically because of many factors. First, gathering information about foreign stocks is more expensive. Foreign companies reveal much less information about their operations than their American counterparts because they do not have the same kind of disclosure requirements. Moreover, the information that is available in the public domain is more difficult to obtain and more expensive. Investors must subscribe to foreign database subscription services, fax services, and foreign newspapers and pay for expedited delivery to obtain the information in a timely manner. And differences in accounting practices mean that financial statements are not easily comparable. These difficulties make research required to value foreign company more expensive and more uncertain. Read more »

Posted: February 14th, 2008 under Future Exchange.
Comments: 3

Marketing Offshore Funds in Italy

To market offshore funds to the public, an application must be made to the Ministry of Treasury and the Ministry of Foreign Trade for authorisation. This will only be granted if these ministries are satisfied that the laws of the jurisdiction in which the offshore futures fund is incorporated are compatible with Italian law. The fund will have to open a representative office in Italy and will also have to either appoint an Italian bank or use a bank from another EC member state that has a branch in Italy that can act as custodian of its assets. Authorisation is deemed to have been granted if not refused within 60 days of the date on which the application was made to the Ministry of Foreign Trade.

1. banks and credit institutions;
2. insurance companies;
3. companies managing mutual funds;
4. stock exchange brokerage companies;
5. financial companies.

Subsequent to any placement, Consob must be notified of the names of purchasing investors, the type of fund and the amounts involved. Read more »

Posted: February 8th, 2008 under Future Fund, Future Investing, Futures Contracts.
Comments: 3

Selling Offshore Funds in Germany

This is governed by the Foreign Investment Fund Act of 1969 (the Act) which applies to funds whose shares are distributed to the public, in its widest sense, in Germany and which invest in securities or real estate with the aim of spreading investment risk.

As a result an offshore fund which invests in futures, and options and is specifically excluded from investing in securities or real estate falls outside the Act. This means that an offshore managed futures fund can be sold widely in Germany as long as it complies with the domestic marketing rules laid out in the Act against Unfair Competition.

`Securities‘ are not defined in the Foreign Investment Fund Act but are interpreted, under general principles, as meaning ‘transferable certificates’ of any sort. Thus, it is not the nature of the underlying instruments but the nature of the document representing the relevant instrument which needs to be considered. Since German futures contracts are not in fact transferable (because the contracts are traded on a back-to-back basis as in the US and the UK), they would not be considered to be securities. Read more »

Posted: February 7th, 2008 under Future Fund, Futures Contracts.
Comments: 3

If you understand the basic principles of hedging and speculating, you will have no trouble applying those concepts to futures contracts on foreign currencies.

Hedging and Speculating with Foreign Currency Futures

We have seen that with the appropriate hedging strategy, farmers can reduce price risk. In the world of international business, another significant risk is foreign exchange risk, or the risk of loss due to shifting relative values in national currencies. The next two chapters will discuss how the futures market enables a portfolio manager to minimize market risk and how bankers can reduce the interest rate risk they face. Read more »

Posted: February 3rd, 2008 under Currency Futures, Futures Contracts, Futures Market, Futures Prices.
Comments: 4