Currency futures can also be forward starts – a client may want to create/hedge a commitment from 4 months and a duration of 6 months. This would be considered a start of 6 months in 4 months – or a 4m * 10m. Such a futures contract would be calculated from the current spot for 4 months and 10 months, with the current spot price being adjusted for the forward price for 4 months to reflect the new starting price. The purpose of an fx futures contract is to set an exchange rate between two currencies at a future time in order to minimize currency risk. This can happen, for example, if a company is contractually obliged to pay a certain amount for the future delivery of goods in a foreign currency and wants to set the rate. Had there been no futures contract, the exporter would have received $11.8 million through the exchange of €10 million at the market exchange rate. Currency futures are most often used in connection with a sale of goods between a buyer in one country and a seller in another country. The contract specifies the amount of money that will be paid by the buyer and received by the seller. Thus, both parties can proceed with a solid knowledge of the cost/value of the transaction. By using a currency futures contract, the parties are able to effectively hedge the exchange rate for a future transaction. Let`s say an American exporter who expects a payment of 10 million euros after 3 months.
Since he has to convert these euros into US dollars, there is a currency risk. The exporter enters into a cash-settled futures contract to exchange €10 million in US dollars after 3 months at a fixed exchange rate of €1 = $1.2 USD. This means that he can exchange his 10 million euros for 12 million US dollars after 3 months. If, in a year, the spot rate is US$1 = C$1.0300 – meaning that the C$was appreciated as expected by the exporter – by setting the forward rate, the exporter received C$35,500 (by selling the US$1 million at C$1.0655 instead of the cash rate of C$1.0300). On the other hand, if the spot rate is C$1.0800 per year (i.e., the Canadian dollar has weakened contrary to the exporter`s expectations), the exporter incurs a notional loss of C$14,500. Unlike other hedging mechanisms such as futures and currency options, which require an upfront payment for margin requirements or premium payments, forward foreign exchange transactions generally do not require an initial payment when used by large companies and banks. For example, suppose Company A in the United States wants to enter into a contract for a future purchase of machine parts from Company B based in France. Therefore, changes in the exchange rate between the US dollar and the euro can affect the actual price of the purchase – up or down. An American company plans to sell products worth 2 million euros to a European company and make sales in 12 months.
The U.S. economy fears that the dollar will strengthen against the euro and reduce the value of its exports. It includes an fx futures contract to sell 2 million euros in 12 months in order to secure the price at $1 = $0.90 and protect its income. If the cash price of one dollar is € 1.10 per year later, the company benefits from the contract. If the dollar has fallen to €0.80, the company loses contract by receiving fewer dollars for the euro than it would have done at the spot rate. For example, suppose the spot rate for the U.S. dollar and the Canadian dollar is 1.3122. The three-month rate in the United States is 0.75% and the three-month rate in Canada is 0.25%. The switch rate for three-month USD/CAD futures contracts would be calculated as follows: A foreign exchange option is a contract that gives the holder the right, but not the obligation, to exchange an amount of one currency for another at a pre-agreed rate (strike rate) no later than a pre-agreed date. On the maturity date, the Bank exercises fx forward to convert your deposit into the purchase currency at the agreed term rate.
However, a currency futures transaction has little flexibility and represents a binding commitment, meaning that the buyer or seller of the contract cannot leave if the «blocked» rate ultimately proves detrimental. .
