Foreign Exchange Option and Documents and Terms in International Trade Week 4 Section 1 Prepared by David LYNN
McGraw-Hill/Irwin
Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
Option Strategies An unlimited variety of payoff patterns can be achieved by combining puts and calls with various exercise prices. I just explain the motivation and structure of the most popular ones.
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Option Strategies Protective Put The purchase of a put option at the same time as taking a long position in the stock or other underlying defined in the put or while already long the underlying defined in the put.
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Option Strategies Imagine you would like to invest in a stock, but you are unwilling to bear potential losses beyond some given level. Investing in the stock alone seems risky to you because in principle you could all the money you invest. You might consider snstead investing in stock and purchasing a put option on the stock.
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Purchasing Stock Pay off Stock
X
St
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Long an Put
Pay of option
X
St
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Value of Protective Put Portfolio at Option Expiration
St< and = X
St > X
Stock Put
St X-St
St 0
Total
X
St
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Protective Put Pay off of Protective call
Pay off
X
X
St
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Foreign exchange option A foreign exchange option (commonly shortened to just FX option) is the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date
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Foreign exchange option For example a USD/GBP FX option might be specified by a contract allowing the purchaser to exchange £1,000,000 into $2,000,000 on December 31st. Question what is the strike price? Which currency is call and which currency is put? If the dollar is stronger than 0.5GBP/USD come December 31st (say at 0.55GBP/USD) then the option will be exercised or not? Why? If it is exercised, how much is the profits in terms of USD and in terms of GBP?
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Foreign exchange option Exercise NZD/USD=0.6 is the strike price in Option contract. The contract is valid on 31th August. You plan to exchange 100 NZD into USD. On the expiration day, the market price is NZD/USD=0.7. What is your strategy?
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Fixed Exchange Rate There are two ways the price of a currency can be determined against another. A fixed, or pegged. Foreign Exchange Rate is a rate the government (central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency. (Usually the U.S. dollar)
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Fixed Exchange Rate There are two ways the price of a currency can be determined against another. A fixed, or pegged. Fixed Exchange Rate is a rate the government (central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency. (Usually the U.S. dollar)
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Floating Exchange Rate Unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand. if demand for a currency is low, its value will decrease, thus making imported goods more expensive and thus stimulating demand for local goods and services. This in turn will generate more jobs, and hence an autocorrection would occur in the market. A floating exchange rate is constantly changing.
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Fixed Exchange Rate
In a floating regime, the central bank may also intervene when it is necessary to ensure stability and to avoid inflation; however, it is less often that the central bank of a floating regime will interfere.
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The World Once Pegged Between 1870 and 1914, there was a global fixed exchange rate. Currencies were linked to gold, meaning that the value of a local currency was fixed at a set exchange rate to gold ounces. This was known as the gold standard. With the start of World War I, the gold standard was abandoned.
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The World Once Pegged At the end of World War II, the conference at Bretton Woods, in an effort to generate global economic stability and increased volumes of global trade, established the basic rules and regulations governing international exchange.
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The World Once Pegged International monetary system, embodied in the International Monetary Fund (IMF), was established to promote foreign trade and to maintain the monetary stability of countries and therefore that of the global economy.
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Documents and Terms in International Trade
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Documents and Terms in International Trade Asia-Pacific Economic Cooperation (APEC) Established in November 1989, the Asia-Pacific Economic Cooperation (APEC) is the premier forum for facilitating economic growth, cooperation, trade and investment in the AsiaPacific region. APEC has 21 members.. McGraw-Hill/Irwin
Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
General Agreement on Tariff and Trade
The General Agreement on Tariffs and Trade (typically abbreviated GATT) was originally created by the Bretton Woods Conference as part of a larger plan for economic recovery after World War II. GATT included a reduction in tariffs and other international trade barriers and is generally considered the precursor to the World Trade Organization.
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