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International Financial Management

Notes background of these markets since firms usually use both currency futures and options to
manage the foreign exchange risk or take speculative positions on currency movements. Both
futures and options not only gives the investors new speculative opportunities, but also provide
new tools for portfolio management and risk control of an existing portfolio. In this unit, we
introduce the currency futures market and currency options market and how these contracts can
be used to manage the different kinds of risks. We begin with the definition and the various
types of futures contract that exist and are traded.

8.1 Concept of Futures

A futures contract represents a contractual agreement to purchase or sell a specified asset in
future for a specified price that is determined today. The underlying asset could be a foreign
currency, a stock index, a treasury bill or any number of other assets. The specified price is
known as the future price. Each contract also specifies the delivery month, which may be nearby
or more deferred in time.
The undertaker in a futures market can have two positions in the contract.

(i) Long position when the buyer of a futures contract agrees to purchase the underlying
asset.
(ii) Short position when the seller agrees to sell the asset.

Futures contract represents an institutionalised, standardised form of forward contracting. They
are traded on an organised exchange which is a physical place or trading floor where listed
contracts are traded face to face.

8.1.1 Types of Futures Contracts

Futures contracts that are traded fall into five categories.
(i) Agricultural Futures Contracts: These contracts are traded in grains, oil and meal, livestock,
forest products, textiles and foodstuff. Several different contracts and months for delivery
are available for different grades or types of commodities in question. The contract months
depend on the seasonality and trading activity.

(ii) Metallurgical Futures Contract: This category includes genuine metal and petroleum
contracts. Among the metals, contracts are traded on gold, silver, platinum and copper.
Of the petroleum products, only heating oil, crude oil and gasoline are traded.
(iii) Interest Rate Futures Contracts: These contracts are traded on treasury bills, notes, bonds,
bank certificates of deposit, Eurodollar deposits and single family mortgages.

(iv) Foreign Exchange Futures Contracts: These contracts are traded in the British pound, the
Canadian dollar, the Japanese yen, the Swiss franc, and the deutsche mark. Contracts are
also listed on French francs, Dutch guilders and the Mexican peso but these have met with
only limited success.
(v) Stock Index Futures Contracts: These futures contract without actual delivery were
introduced only in 1982 and are the most recent major futures contract to emerge. In the
United States, these contracts trade on several market indices like Standard and Poor’s 500,
a major market index, the NYSE Index and the Value Line Index. Numerous contracts on
industry indices are now trading as well.

A stock index futures contract is a contract to buy or sell the face value of the underlying stock
index where the face value is defined as being the value of index multiplied by the specified
monetary amount.

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