Futures market participants

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Futures contracts are deals made now to take place in the future. In a futures contract, the buyer and the seller agree on:

1 A future delivery date.

2 The price to be paid on that future date.

3 The quantity of the currency.

The currency futures market was created for those who use foreign exchange in business. Businesses, which deal with international transactions, routinely buy and sell foreign exchange in the spot market. They enter the futures market only to protect themselves against risks from volatile exchange rates. The currency futures contract is like an insurance policy against changes in exchange rates. In practice, most currency futures contracts are nullified by opposing trades, so futures traders rarely take delivery of a foreign currency; in fact, nearly 98 percent of them are terminated before delivery.

There are two distinct classes of traders in the currency futures market: hedgers and speculators. Hedgers buy and sell currency futures contracts to protect the home currency value of foreign currency denominated assets and liabilities. They include MNCs, importers, exporters, bankers, and brokers, who require protection against adverse exchange rate movements. They expect their profits to come from managerial skills in conducting their business activities, not from incidental fluctuations in exchange rates. Speculators, on the other hand, buy and sell currency futures contracts for profit from exchange rate movements. They trade futures strictly for profit; they can make or lose fortunes. A speculator trades currency futures but never uses the currency.

A hedger may place a contract with another hedger who wishes to cover currency needs in the opposite direction, but the other party to the contract typically is a speculator. Though criticized for greed, speculators play a vital role in futures markets by assuming the risk of the hedger. Their presence not only gives the market liquidity and continuity but also eases entry and exit.

Currency futures trading can take place for hedging or speculation, as well as for arbitrage. In particular, some traders quickly take advantage of any profitable differential, for the same

Table 6.1 Currencies traded on the Chicago Mercantile Exchange

Currency

Contract size

Australian dollar Brazilian real British pound Canadian dollar Euro

Japanese yen Mexican peso New Zealand dollar Russian ruble South African rand Swiss franc

A$100,000

R100,000

Can$100,000

Mex$500,000

NZ$100,000

RR500,000

R500,000

SFr125,000

Cross rate futures (underlying currency/price currency) Euro/British pound 125,000

Euro/Japanese yen 125,000

Euro/Swiss franc 125,000

currency, between rates quoted in different markets, such as the spot market, the futures market, and the forward market.

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