A currency future, which is also referred to as FX future or foreign exchange future, is a futures contract. It is used 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. Then the price of a future is settled down in terms of US dollars per unit of other currency.
This method can be different from the standard way of quoting in the spot foreign exchange markets. A certain amount of other currency is the trade unit of each contract, for instance €125,000. Most contracts posses physical delivery, so for those contracts that are held at the end of the last trading day, actual payments are made in each currency. However, before that most of the contracts are closed out. The contracts can be closed out by the investors at any time prior to the contract’s delivery date.
History
Less than one year after the system of fixed exchange rates was abandoned along with the gold standard, in 1972 Currency futures were first created at the Chicago Mercantile Exchange (CME). In the early 1970s, some commodity traders at the CME did not have access to the inter-bank exchange markets, when they presumed that significant changes were about to take place in the currency market.
The International Monetary Market (IMM) was established by them and they also launched trading in seven currency futures on May 16, 1972. At present, the IMM is a division of CME. An average of 332,000 contracts having a notional value of $43 billion were traded every day, in the second quarter of 2005. Currently most of these contracts are traded electronically.
Other futures exchanges by which currency futures are traded includes Euronext.liffe and Tokyo Financial Exchange
Uses of Currency Futures
Hedging
These futures contracts are used by the investors to hedge against foreign exchange risk. If a cashflow denominated in a foreign currency would be received by an investor on some future date, then the current exchange rate can be locked in by the investor by entering into an offsetting currency futures position that expires on the date of the cashflow.
For instance, Jassica is a US-based investor by whom €1,000,000 would be received on December 1. The current exchange rate that is implied by the futures is $1.2/€. This exchange rate can be locked in by her by selling €1,000,000 worth of futures contracts expiring on December 1. By doing these, she is guaranteed an exchange rate of $1.2/€ regardless of any fluctuations that takes place in the exchange rate in the meantime.
Speculation
Traders can also use Currency futures to speculate and, by incurring a risk, attempt to profit from rising or falling exchange rates.
For example, 10 September CME Euro FX Futures is bought by John, at €1.2713/$. At the day end, the futures close at $1.2784/€. The change in price is €0.0071/$. As each contract is over €125,000, and he has got 10 contracts with him, so he will get the of $8,875. As with any future, he will get this payment immediately.
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Posted by R. MAK. in Currency Trade, Forex Basics, Forex Market · 0 Comment
