Currency future
Encyclopedia
A currency future, also FX future or foreign exchange future, is a futures contract
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; see Foreign exchange derivative
. Typically, one of the currencies is the US dollar
. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange market
s. The trade unit of each contract is then a certain amount of other currency, for instance €125,000. Most contracts have physical delivery, so for those held at the end of the last trading day, actual payments are made in each currency. However, most contracts are closed out before that. Investors can close out the contract at any time prior to the contract's delivery date.
was still in effect. They did so a full two years before the Chicago Mercantile Exchange
(CME) in 1972, less than one year after the system of fixed exchange rate
s was abandoned along with the gold standard
. Some commodity traders at the CME did not have access to the inter-bank exchange markets in the early 1970s, when they believed that significant changes were about to take place in the currency market. The CME actually now gives credit to the International Commercial Exchange (not to be confused with the ICE for creating the currency contract, and state that they came up with the idea independently of the International Commercial Exchange). The CME established the International Monetary Market
(IMM) and launched trading in seven currency futures on May 16, 1972. Today, the IMM is a division of CME. In the fourth quarter of 2009, CME Group FX volume averaged 754,000 contracts per day, reflecting average daily notional value of approximately $100 billion. Currently most of these are traded electronically.
Other futures exchange
s that trade currency futures are Euronext.liffe http://www.euronext.com/trader/currencies/0,4860,1732_200511154,00.html, Tokyo Financial Exchange
http://www.tfx.co.jp/en/ and IntercontinentalExchange
http://www.theice.com.
, namely the third Wednesday in March, June, September and December. The conventional option maturity dates are the first Friday after the first Wednesday for the given month.
against foreign exchange risk. If an investor will receive a cashflow denominated in a foreign currency on some future date, that investor can lock in the current exchange rate by entering into an offsetting currency futures position that expires on the date of the cashflow.
For example, Jane is a US-based investor who will receive €1,000,000 on December 1. The current exchange rate implied by the futures is $1.2/€. She can lock in this exchange rate by selling €1,000,000 worth of futures contracts expiring on December 1. That way, she is guaranteed an exchange rate of $1.2/€ regardless of exchange rate fluctuations in the meantime.
For example, Peter buys 10 September CME Euro FX Futures, at $1.2713/€. At the end of the day, the futures close at $1.2784/€. The change in price is $0.0071/€. As each contract is over €125,000, and he has 10 contracts, his profit is $8,875. As with any future, this is paid to him immediately.
More generally, each change of $0.0001/€ (the minimum Commodity tick
size), is a profit or loss of $12.50 per contract.
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...
to exchange one currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
for another at a specified date in the future at a price (exchange rate
Exchange rate
In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency...
) that is fixed on the purchase date; see Foreign exchange derivative
Foreign exchange derivative
A Foreign exchange derivative is a financial derivative where the underlying is a particular currency and/or its exchange rate. These instruments are used either for currency speculation and arbitrage or for hedging foreign exchange risk. For detail see:...
. Typically, one of the currencies is the US dollar
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange market
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
s. The trade unit of each contract is then a certain amount of other currency, for instance €125,000. Most contracts have physical delivery, so for those held at the end of the last trading day, actual payments are made in each currency. However, most contracts are closed out before that. Investors can close out the contract at any time prior to the contract's delivery date.
History
Currency futures were first created in 1970 at the International Commercial Exchange in New York. But the contracts did not "take off" due to the fact that the Bretton Woods systemBretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
was still in effect. They did so a full two years before the Chicago Mercantile Exchange
Chicago Mercantile Exchange
The Chicago Mercantile Exchange is an American financial and commodity derivative exchange based in Chicago. The CME was founded in 1898 as the Chicago Butter and Egg Board. Originally, the exchange was a non-profit organization...
(CME) in 1972, less than one year after the system of fixed exchange rate
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...
s was abandoned along with the gold standard
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
. Some commodity traders at the CME did not have access to the inter-bank exchange markets in the early 1970s, when they believed that significant changes were about to take place in the currency market. The CME actually now gives credit to the International Commercial Exchange (not to be confused with the ICE for creating the currency contract, and state that they came up with the idea independently of the International Commercial Exchange). The CME established the International Monetary Market
International Monetary Market
The International Monetary Market , a spin-off from the old Chicago Mercantile Exchange and largely the creation of Leo Melamed, is today one of three divisions of the Chicago Mercantile Exchange , the largest futures exchange in the United States and the second largest in the world after Eurex,...
(IMM) and launched trading in seven currency futures on May 16, 1972. Today, the IMM is a division of CME. In the fourth quarter of 2009, CME Group FX volume averaged 754,000 contracts per day, reflecting average daily notional value of approximately $100 billion. Currently most of these are traded electronically.
Other futures exchange
Futures exchange
A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of...
s that trade currency futures are Euronext.liffe http://www.euronext.com/trader/currencies/0,4860,1732_200511154,00.html, Tokyo Financial Exchange
Tokyo Financial Exchange
is a futures exchange and established in April 1989 under the Financial Futures Trading Law of Japan. It principally deals in financial instrument markets that handles securities as well as market derivatives....
http://www.tfx.co.jp/en/ and IntercontinentalExchange
IntercontinentalExchange
IntercontinentalExchange, Inc., known as ICE, is an American financial company that operates Internet-based marketplaces which trade futures and over-the-counter energy and commodity contracts as well as derivative financial products...
http://www.theice.com.
Terms
As with other futures, the conventional maturity dates are the IMM datesIMM dates
The IMM dates are the four quarterly dates of each year which most futures contracts and option contracts use as their scheduled maturity date or termination date...
, namely the third Wednesday in March, June, September and December. The conventional option maturity dates are the first Friday after the first Wednesday for the given month.
Hedging
Investors use these futures contracts to hedgeHedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...
against foreign exchange risk. If an investor will receive a cashflow denominated in a foreign currency on some future date, that investor can lock in the current exchange rate by entering into an offsetting currency futures position that expires on the date of the cashflow.
For example, Jane is a US-based investor who will receive €1,000,000 on December 1. The current exchange rate implied by the futures is $1.2/€. She can lock in this exchange rate by selling €1,000,000 worth of futures contracts expiring on December 1. That way, she is guaranteed an exchange rate of $1.2/€ regardless of exchange rate fluctuations in the meantime.
Speculation
Currency futures can also be used to speculate and, by incurring a risk, attempt to profit from rising or falling exchange rates.For example, Peter buys 10 September CME Euro FX Futures, at $1.2713/€. At the end of the day, the futures close at $1.2784/€. The change in price is $0.0071/€. As each contract is over €125,000, and he has 10 contracts, his profit is $8,875. As with any future, this is paid to him immediately.
More generally, each change of $0.0001/€ (the minimum Commodity tick
Commodity tick
Futures exchanges establish a minimum amount that the price of a commodity can fluctuate upward or downward. This minimum fluctuation is known as a tick or commodity tick...
size), is a profit or loss of $12.50 per contract.