Chapter 7 Flashcards
(5 cards)
What are the basic differences between the currency forward market and the futures market?
The forward market is OTC and contracts are customized with settlement at maturity. Futures are standardized, exchange-traded, marked-to-market daily, and are usually closed with a reversing trade, not delivery.
Why are both hedgers and speculators needed for an efficient derivatives market?
Hedgers seek to reduce price risk by locking in prices, while speculators assume that risk to profit from price movements. Their interaction provides liquidity and efficiency to the market.
Why are most futures contracts closed out through a reversing trade rather than held to delivery?
Futures contracts have standardized dates unlikely to match actual FX needs. Most traders use them for hedging or speculation, so they close positions via reversing trades, not physical delivery.
How is the FX futures market used for price discovery?
By analyzing the prices of futures contracts with different expiration dates, one can infer market expectations of future spot rates and currency movements.
What is the key difference in obligation between futures/forwards and options contracts?
Futures/forwards obligate the holder to transact at the set price at maturity. Options give the right, but not the obligation, to transact, and require a premium to be paid upfront.
