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International Financial Management
Notes Options provide major possibilities in the range of tools available to treasures and traders.
They can be used on their own to hedge or they can be combined with the forward and
futures markets to achieve more complex hedges.
Futures require daily margins to cover credit risk while forwards require a bank credit
line. An option buyer can dispense with either depending on the specific market in which
he operates.
8.4.2 Trading of Options
FX options are traded in two distinct markets:
1. OTC: The largest, by far, is the OTC market (OTC just means ‘direct between counterparties’)
which comprises banks, American securities houses and corporates. There is no central
marketplace as such. All transactions are conducted over the telephone or through the
Reuter’s Dealing System and is open 24 hours a day. Telex is rarely used these days except
as a form of written confirmation for deals already concluded.
The market participants deal with each other, either directly or through an OTC broker,
quoting volatility rates as the dealing price (rather than in currency prices). The brokers
act to bring counterparties together but have no part in the transaction itself. As in the spot
FX markets, a fee is levied on both counterparties by the broker for such deals. Trades
concluded directly are commission free (so there are no fees when a corporate deals with
its bank).
2. Exchange Listed: The other market for FX options is the exchange listed markets of the
various stock and futures exchanges around the world. The principal centres are
Philadelphia, where the stock exchange lists options on spot FX and Chicago, where the
Mercantile Exchange lists options on its FX futures contracts. In both cases, quotations are
in the form of currency (rather than volatility).
Access to the market is through brokers who impose commissions for each contract traded.
The market operates on the floor of the exchange where brokers gather to reflect their
clients’ orders with market makers or specialists providing the prices. The markets have
specified opening and closing times for each currency contract. Also, the exchanges have
widened the availability by extending trading hours.
Self Assessment
Fill in the blanks:
12. …………………… require daily margins to cover credit risk.
13. …………………… provide a flexible hedge offering a range of prices where the option can
be exercised.
Caselet Currency Swap Pact between by IFC and SBI
he World Bank’s private lending arm, International Finance Corporation entered
into a currency swap agreement with State Bank of India as part of efforts to increase
Tits business in the country further from $400 million Since FY 2000.
Contd...
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