CHAPTER 7 - FUTURES AND OPTIONS ON FOREIGN EXCHANGE - ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS

Aug 31, 2026

Chapter 7 covers futures and options in the foreign exchange context, providing structured solutions to end-of-chapter questions. It explains how currency forward markets differ from futures markets, the roles of hedgers and speculators in derivatives markets, and why most futures positions are closed using reversing trades instead of delivery. It also addresses price discovery in FX futures, compares obligations under futures/forwards versus options, defines in-/at-/out-of-the-money terminology, and outlines how call/put option values depend on key model variables.

LanguageEnglish

CategoryPaper Templates

FormatDOCX

Pages98

Reading Time34 min

AccessFree to download

Chapter 7 Futures and Options on Foreign Exchange

Answers and Solutions to End-of-Chapter Questions and Problems

Questions 1-7

CHAPTER 7 FUTURES AND OPTIONS ON FOREIGN EXCHANGE ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Explain the basic differences between the operation of a currency forward market and a futures market. Answer: The forward market is an OTC market where the forward contract for purchase or sale of foreign currency is tailor-made between the client and its international bank. No money changes hands until the maturity date of the contract when delivery and receipt are typically made. A futures contract is an exchange-traded instrument with standardized features specifying contract size and delivery date. Futures contracts are marked-to-market daily to reflect changes in the settlement price. Delivery is seldom made in a futures market. Rather a reversing trade is made to close out a long or short position. 2. In order for a derivatives market to function most efficiently, two types of economic agents are needed: hedgers and speculators. Explain. Answer: Two types of market participants are necessary for the efficient operation of a derivatives market: speculators and hedgers. A speculator attempts to profit from a change in the futures price. To do this, the speculator will take a long or short position in a futures contract depending upon his expectations of future price movement. A hedger, on-the-other-hand, desires to avoid price variation by locking in a purchase price of the underlying asset through a long position in a futures contract or a sales price through a short position. In effect, the hedger passes off the risk of price variation to the speculator who is better able, or at least more willing, to bear this risk. 3. Why are most futures positions closed out through a reversing trade rather than held to delivery? Answer: In forward markets, approximately 90 percent of all contracts that are initially established result in the short making delivery to the long of the asset underlying the contract. This is natural because the terms of forward contracts are tailor-made between the long and short. By contrast, only about one percent of currency futures contracts result in delivery. While futures contracts are useful for speculation and hedging, their standardized delivery dates make them unlikely to correspond to the actual future dates when foreign exchange transactions will occur. Thus, they are generally closed out in a reversing trade. In fact, the commission that buyers and sellers pay to transact in the futures market is a single amount that covers the round-trip transactions of initiating and closing out the position. 4. How can the FX futures market be used for price discovery? Answer: To the extent that FX forward prices are an unbiased predictor of future spot exchange rates, the market anticipates whether one currency will appreciate or depreciate versus another. Because FX futures contracts trade in an expiration cycle, different contracts expire at different periodic dates into the future. The pattern of the prices of these contracts provides information as to the market’s current belief about the relative future value of one currency versus another at the scheduled expiration dates of the contracts. One will generally see a steadily appreciating or depreciating pattern; however, it may be mixed at times. Thus, the futures market is useful for price discovery, i.e., obtaining the market’s forecast of the spot exchange rate at different future dates. 5. What is the major difference in the obligation of one with a long position in a futures (or forward) contract in comparison to an options contract? Answer: A futures (or forward) contract is a vehicle for buying or selling a stated amount of foreign exchange at a stated price per unit at a specified time in the future. If the long holds the contract to the delivery date, he pays the effective contractual futures (or forward) price, regardless of whether it is an advantageous price in comparison to the spot

FAQs

What is the main difference between a currency forward market and a futures market?

The forward market is OTC with tailor-made terms between client and bank and typically no money changes hands until maturity, while futures trade on an exchange with standardized contract features and daily marking-to-market. Delivery is seldom made in futures because positions are usually closed through reversing trades.

Why does an efficient derivatives market need both hedgers and speculators?

Speculators aim to profit from futures price changes by taking long or short positions based on expectations. Hedgers seek to reduce risk by locking in purchase or sales prices, effectively transferring price-variation risk to speculators.

How are FX futures used for price discovery?

Assuming FX forward prices are unbiased predictors of future spot rates, the market reveals expectations about appreciation or depreciation through an expiration cycle. Different contract expiration dates generate a price pattern that forecasts spot exchange rates at those future dates.

Aug 31, 2026

Upload by Maya Linwood