A
currency future, also FX future or foreign exchange
future, is a futures contract to exchange one currency for
another at a specified date in the future at a price (exchange
rate) that is fixed on the purchase date. Typically, one of the
currencies is the US dollar. The price of a future is then
in terms of US dollars per unit of other currency. This can be
different from the standard way of quoting in the spot foreign
exchange markets. The trade unit of each contract is then
a certain amount of other currency, for instance €125,000. Most
contracts have physical delivery, so for those held at the end
of the last trading day, actual payments are made in each currency.
However, most contracts are closed out before that. Investors
can close out the contract at any time prior to the contract's
delivery date.
History
Currency
futures were first created at the Chicago Mercantile Exchange
(CME) in 1972, less than one year after the system of fixed
exchange rates was abandoned along with the gold standard. Some
commodity traders at the CME did not have access to the inter-bank
exchange markets in the early 1970s, when they believed that
significant changes were about to take place in the currency
market. They established the International Monetary Market (IMM)
and launched trading in seven currency futures on May 16, 1972.
Today, the IMM is a division of CME. In the second quarter of
2005, an average of 332,000 contracts with a notional value
of $43 billion were traded every day. Currently most
of these are traded electronically [1].
Other futures
exchanges that trade currency futures are Euronext.liffe [2]
and Tokyo Financial Exchange [3]
The IMM
dates are the third Wednesday in March, June, September and
December.
Pricing
-
The pricing
of a currency futures contract is completely determined by the
prevailing spot rate and interest rates. Otherwise, investors
would be able to arbitrage the difference between the futures
and spot prices.
The futures
price is given by:
where:
- F = futures
price
- S = spot
price
- rT
= interest rate of the term currency
- rB
= interest rate of the base currency
- T = tenor
(calculated according to the appropriate day count convention)
Uses
Hedging
Investors
use these futures contracts to hedge against foreign exchange
risk. If an investor will receive a cashflow denominated in
a foreign currency on some future date, that investor can lock
in the current exchange rate by entering into an offsetting
currency futures position that expires on the date of the cashflow.
For example,
Jane is a US-based investor who will receive €1,000,000 on
December 1. The current exchange rate implied by the futures
is $1.2/€. She can lock in this exchange rate by selling €1,000,000
worth of futures contracts expiring on December 1. That way,
she is guaranteed an exchange rate of $1.2/€ regardless of
exchange rate fluctuations in the meantime.
Speculation
Currency
futures can also be used to speculate and, by incurring a risk,
attempt to profit from rising or falling exchange rates.
For example,
Peter buys 10 September CME Euro FX Futures, at $1.2713/€.
At the end of the day, the futures close at $1.2784/€. The
change in price is $0.0071/€. As each contract is over €125,000,
and he has 10 contracts, his profit is $8,875. As with any future,
this is paid to him immediately. Edit: Quoting for FX Futures
at CME is in €/$ not $/€!
More generally,
each change of $0.0001/€ (the minimum Commodity tick size),
is a profit or loss of $12.50 per contract.}}