CIMA F3 Syllabus C. Financial risks - Currency Futures - Notes ^{4 / 6}

• It’s a standard contract for set amount of currency at a set date

• It is a market traded forward rate basically

  *Calculations of how these work are required only for P4 exam (not F9)

Explanation

When a currency futures contract is bought or sold, the buyer or seller is required to deposit a sum of money with the exchange, called initial margin.

If losses are incurred as exchange rates and hence the prices of currency futures contracts change, the buyer or seller may be called on to deposit additional funds (variation margin) with the exchange

Equally, profits are credited to the margin account on a daily basis as the contract is ‘marked to market’.

Most currency futures contracts are closed out before their settlement dates by undertaking the opposite transaction to the initial futures transaction, ie if buying currency futures was the initial transaction, it is closed out by selling currency futures. A gain made on the futures transactions will offset a loss made on the currency markets and vice versa.

Features of currency future contracts:

1. Futures contracts can be bought or sold in the futures market and the price of the contract is effectively the exchange rate at which the deal is done

2. Futures contracts are available on a 3 monthly cycle

3. All buyers and sellers of futures have to pay a deposit to the exchange when they buy or sell

4. The prices of the futures move in line with the underlying asset

Advantages

1. Lower transaction costs than money market

2. They are tradeable and so do not need to always be closed out

Disadvantages

1. Cannot be tailored as they are standard contracts

2. Only available in a limited number of currencies

3. Still cannot take advantage of favourable movements in actual exchange rates (unlike in options…next!)