foreignexchangeinstruments,measuringandmanagingforeign（6页）.doc

FOREIGN EXCHANGE INSTRUMENTS, MEASURING AND MANAGING FOREIGN EXCHANGE EXPOSURE FORWARDS, FUTURES, OPTIONS, SWAPS AND EXPOSURE HEDGING A forward contract is an agreement between two parties to buy or sell an asset in the future. A futures contract is a version of a forward contract that has been standardized. Futures contracts are listed on an exchange. There are several distinctions between forward and futures contracts. First, forward contracts are generally traded by large institutional investors who are geographically dispersed, while futures contracts trade on centralized exchanges. As of 1992, the Chicago Mercantile Exchange launched GLOBEX, which allows after-hours trading of listed futures contracts. Second, as previously mentioned forward contracts are customized, while futures contracts are standardized. One aspect of this standardization is in the form of payment risk. With futures contracts, clearinghouses such as banks take the responsibility for settlement, while forward contracts have possible counterparty risk as the loosing party might default at the time of payment. Finally, with a forward contract no cash flows take place until the final maturity of the contract, but a futures contract requires an initial margin amount and are “marked-to-market” allowing customers greater liquidity. Currency and Interest Rate Futures Currency futures contracts specify the price at which a currency can be bought or sold at a future date. They are used to hedge foreign exchange risk. These contracts are “marked-to-market” daily; therefore, investors can buy or sell these instruments on a daily basis. The value (F) of a futures contract is the current spot price (S) multiplied by one plus the interest rate over period (t), plus the cost of storage which is a function of time and the current spot price. (1) Interest rate futures are the most actively traded futures contracts in the world. They are based on relative interest rates and are used t