Financial Management in the International Corporation Exchange Rates and International Parity Conditions Monday, January 12, 1998 - PowerPoint PPT Presentation

Loading...

PPT – Financial Management in the International Corporation Exchange Rates and International Parity Conditions Monday, January 12, 1998 PowerPoint presentation | free to view - id: 7af352-NzE2N



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Financial Management in the International Corporation Exchange Rates and International Parity Conditions Monday, January 12, 1998

Description:

Title: Financial Management in the International Corporation Exchange Rates and International Parity Conditions Monday, January 12, 1998 Author – PowerPoint PPT presentation

Number of Views:66
Avg rating:3.0/5.0
Slides: 106
Provided by: arta96
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Financial Management in the International Corporation Exchange Rates and International Parity Conditions Monday, January 12, 1998


1

HEDGING FOREIGN CURRENCY RISK OPTIONS
2
the options markets are fertile grounds for
imaginative, quick thinking individuals with any
type of risk profile. The possibility set is
limited only by the creativity of the
participantsHuge growth in derivatives
markets from 250,000,000 contracts in 1988 to
1,630,000,000 contracts in 2009.
3
Currency options
  • Currency options began trading on the
    Philadelphia Stock Exchange (PHLX) in 1982
  • More option exchanges around the world,
  • more currencies and debt instruments on which
    options are traded
  • option contracts with longer maturities
  • more styles of option contracts, and
  • greater volume of trading activity

4
Types of contracts
  • A call option bestows on the owner the right, but
    not the obligation, to buy the underlying
    financial asset or commodity.
  • A put option conveys to the owner the right, but
    not the obligation, to sell the underlying
    financial asset or commodity.
  • A European option can be exercised once only at
    the maturity date of the option.
  • An American option can be exercised at any time
    on or before the maturity date.

5
Why options?
While foreign currency options and futures are
largely similar - they trade on organized
exchanges at pre-specified quantities and
maturities - they differ in up to three main
ways 1. The holder of an option has the right
but not the obligation to trade currencies at a
pre-specified rate at some future date with
futures contracts, holders are required to
exchange currencies. 2. While there exists a
single rate at which parties in a futures
contract agree to exchange currencies in the
future, the pre-specified option exchange rate
can be selected from any of a number of possible
rates (known as strike-prices).
6
Why options?
3. While futures contracts allow for the exchange
of currencies only at the maturity date, some
option contracts (know as American-style
options) allow the holder to trade at the strike
price at any time up to the maturity date. The
major benefit of using options in hedging is that
they can be used to hedge potential transactions,
or transactions that are contingent upon
something else.
7
Types of contracts
  • Examples
  • An American call option on spot
  • The right to buy 1 million for 1.10 per from
    today until expiration on Dec 15, 2006.
  • This call on is also a put on US.
  • A European put option on Swiss franc
  • The right to sell SFr 10 million March 2002 for
    0.65 per SFr on (and only on) Mar 15, 2002.
  • This put on SFr is also a call on US.

8
Contract specifications
The buyer of this call option would expect to pay
62,500 ? 0.0189 1,181.25 plus commission
charges.
9
European Call and Put
The holder of a EUROPEAN CALL option has the
RIGHT but not the obligation to buy currencies
at a pre-specified rate (STRIKE PRICE) at some
future date (EXPIRATION DAY). M size of
position c call price cT European call
payoff X strike price T expiration day S0
spot exchange rate today ST spot exchange rate
at expiration day
10
European Call and Put
From the Financial Times 62,500 Euro - European
Style Expiring in May and a strike price of
1.65. c 0.0081 per Euro of contract X
1.650 /Euro T today - May S0
1.6214 /Euro M 62,500 Euro
11
European Call and Put
Payoff cT ??? What if ST 1.700
/Euro? Exercise call (buy 62,500 Euros buy
paying 1.650 per Euro). Payoff 62,500
(1.700 - 1.650) 3,125 Profit 3,125 - 62,500
0.0081 2,618.75
12
European Call and Put
Payoff cT ??? What if ST 1.600 /Euro? Do
not exercise call. If you do, you end up with
losses. Payoff 0 Profit 0 - 62,500 0.0081
- 506.25 Loss 506.25
13
European Call and Put
Payoff cT ??? What if ST 0.600 /Euro? Do
not exercise call. If you do you end up with
losses. Payoff 0 Profit 0 - 62,500 0.0081
- 506.25 Loss 506.25 Payoff cT M
max 0 , ST - X Profit M ( max 0 , ST -
X - c )
14
Long foreign currency call
Profit or Loss
0
15
Long foreign currency call
Profit or Loss
X
0
S
Strike Price
16
Long foreign currency call
Profit or Loss
X
0
S
Value of exchange rate at expiration day
17
Long foreign currency call
Profit or Loss
X
0
S
Risk of Loss
ST lt X
Profit - M c
18
Long foreign currency call
Profit or Loss
X
Possible Profit
0
S
ST gt X
Profit M ( ST - X ) - c
19
Long foreign currency call
Profit or Loss
X
Possible Profit
0
S
Risk of Loss
ST lt X
ST gt X
Profit M ( max 0 , ST - X - c )
20
European Call and Put
The holder of a EUROPEAN PUT option has the RIGHT
but not the obligation to short currencies at a
pre-specified rate (STRIKE PRICE) at some future
date (EXPIRATION DAY).
pT M max 0 , X - ST Profit M ( max
0 , X - ST - p )
21
Long foreign currency put
Profit or Loss
X
0
S
22
Long foreign currency put
Profit or Loss
X
Possible Profit
0
S
ST lt X
Profit M ( X - ST ) - p
23
Long foreign currency put
Profit or Loss
X
0
Risk of Loss
S
ST gt X
Profit - M p
24
Long foreign currency put
Profit or Loss
X
Possible Profit
0
Risk of Loss
S
ST lt X
ST gt X
Profit M ( max 0 , X - ST - p )
25
Short foreign currency call
Profit or Loss
0
S
X
26
Short foreign currency call
Profit or Loss
Possible Profit
0
S
Risk of Loss
X
ST lt X
Profit M c
27
Short foreign currency call
Profit or Loss
0
S
Risk of Loss
X
ST gt X
Profit - M max 0 , ST - X
28
Short foreign currency call
Profit or Loss
Possible Profit
0
S
Risk of Loss
X
ST lt X
ST gt X
Profit - M ( max 0 , ST - X - c )
29
Short foreign currency put
Profit or Loss
0
S
X
30
Short foreign currency put
Profit or Loss
0
S
X
ST lt X
Risk of Loss
Profit - M max 0 , X - ST
31
Short foreign currency put
Profit or Loss
Possible Profit
0
S
X
ST gt X
Profit M p
32
Short foreign currency put
Profit or Loss
Possible Profit
0
S
X
ST lt X
Risk of Loss
ST gt X
Profit - M ( max 0 , X - ST - p)
33
  • Option which would generate profit if exercised
    immediately is said to be in the money.

34
  • In the money StgtX for Calls and StltX for Puts.

35
  • In the money StgtX for Calls and StltX for Puts.
  • Option which would generate zero profit if
    exercised immediately is said to be at the money.

36
  • In the money StgtX for Calls and StltX for Puts.
  • At the money StX for Calls and StX for Puts.

37
  • In the money StgtX for Calls and StltX for Puts.
  • At the money StX for Calls and StX for Puts.
  • Option which would generate losses if exercised
    immediately is said to be out of the money.

38
  • In the money StgtX for Calls and StltX for Puts.
  • At the money StX for Calls and StX for Puts.
  • Out of the money StltX for Calls and StgtX for
    Puts.

39
How does it compare to Forwards?
Remember that Forward is the obligation to long
or short currency at some pre-specified price at
some future date. Option is the right to long or
short currency at some pre-specified price at
some future date. You do not pay anything for the
forward contract! But you have to pay for the
option! Why? You need to pay for the right!
40
How does it compare to Forwards?
Profit or Loss

Long forward
S
X
Remember that long forward payoff looks like
41
How does it compare to Forwards?
Profit or Loss
0
S
X
What if we long call...
42
How does it compare to Forwards?
Profit or Loss
Long call
0
S
X
What if we long call...
43
How does it compare to Forwards?
Profit or Loss
Short put
0
S
X
What if we long call and short put with identical
strikes and expiration dates?
44
How does it compare to Forwards?
Profit or Loss
Long call
Short put
0
S
X
What if we long call and short put with identical
strikes and expiration dates?
45
How does it compare to Forwards?
Long Forward long call short put
What if we long call and short put with identical
strikes and expiration dates?
46
How does it compare to Forwards?
Profit or Loss

Long forward
0
S
X
Remember that long forward payoff looks like
47
How does it compare to Forwards?
Profit or Loss
Short forward
0
S
X
Remember that short forward payoff looks like
48
How does it compare to Forwards?
Profit or Loss
0
S
X
What if we short call ...
49
How does it compare to Forwards?
Profit or Loss
0
S
X
What if we short call and long put with identical
strikes and expiration dates?
50
How does it compare to Forwards?
Profit or Loss
0
S
X
What if we short call and long put with identical
strikes and expiration dates?
51
How does it compare to Forwards?
Long Forward short call long put
What if we short call and long put with identical
strikes and expiration dates?
52
How does it compare to Forwards?
Profit or Loss
Short forward
0
S
X
Remember that short forward payoff looks like
53
Using options
54
Trading strategies
Ok, options are flexible, but can they be even
more flexible? Yes, you can achieve any payoff
combination by longing, shorting calls and puts
with the same or different strikes and / or
expiration dates! Example suppose that you are
pretty sure that the exchange rate is going to be
very volatile but you do not know the direction
of the change. You want to be paid when it is
very low or very high but you do not want to lose
when it stays the same. You need Straddle.
55
Trading strategies
Straddle
X
ST
56
Trading strategies
long put ...
X
ST
long put
57
Trading strategies
long put and long call with the same strike
price and expiration date.
X
ST
long call
58
Trading strategies
long put and long call with the same strike
price and expiration date.
X
ST
long call
long put
59
Trading strategies
long put and long call with the same strike
price and expiration date.
Straddle
X
ST
long call
long put
60
Trading strategies
long put and long call with the same strike
price and expiration date.
Straddle
X
ST
long call
long put
61
Trading strategies
long put and long call with the same strike
price and expiration date.
Straddle
X
ST
long call
long put
62
Trading strategies
long put and long call with the same strike
price and expiration date.
Straddle
X
ST
63
Trading strategies
long call and put with the same strike price and
expiration date. Price Call Payoff Put
Payoff Total Payoff ST lt X 0 X - ST X - ST ST
gt X ST - X 0 ST - X
64
Trading strategies
What if you think of making money on exchange
rate stability? Solution Butterfly Spread
65
Trading strategies
ST
Butterfly spread
66
Trading strategies
Butterfly spread long call with X1
long call
X1
ST
Butterfly spread
67
Trading strategies
Butterfly spread long call with X1 short call
with X2
short call
X1
ST
X2
68
Trading strategies
Butterfly spread long call with X1 short call
with X2 long call with X3.
long call
X3
X1
ST
X2
69
Trading strategies
Butterfly spread long call with X1 short call
with X2 long call with X3.
long call
short call
long call
X3
X1
ST
X2
70
Trading strategies
Butterfly spread long call with X1 short call
with X2 long call with X3.
long call
short call
long call
X3
X1
ST
X2
71
Trading strategies
Butterfly spread long call with X1 short call
with X2 long call with X3.
long call
short call
long call
X3
X1
ST
X2
72
Trading strategies
Butterfly spread long call with X1 short call
with X2 long call with X3.
long call
short call
long call
X3
X1
ST
X2
73
Trading strategies
Butterfly spread long call with X1 short call
with X2 long call with X3.
long call
short call
long call
X3
X1
ST
X2
74
Trading strategies
Butterfly spread long call with X1 short 2
calls with X2 long call with X3.
long call
short call
long call
X3
X1
ST
Butterfly spread
X2
75
Trading strategies
Butterfly spread long call with X1 short 2
calls with X2 long call with X3.
X3
X1
ST
Butterfly spread
X2
76
Trading strategies
Strangle
X2
X1
ST
77
Trading strategies
Strangle long put with X1
X2
X1
ST
long put
78
Trading strategies
Strangle long put with X1 long call with X2
X2
X1
ST
long call
79
Trading strategies
Strangle long put with X1 long call with X2
X2
X1
ST
long put
long call
80
Trading strategies
Strangle long put with X1 long call with X2
Strangle
X2
X1
ST
long put
long call
81
Trading strategies
Strangle long put with X1 long call with X2
Strangle
X2
X1
ST
long put
long call
82
Trading strategies
Strangle long put with X1 long call with X2
Strangle
X2
X1
ST
long put
long call
83
Trading strategies
Strangle long put with X1 long call with X2
Strangle
X2
X1
ST
long put
long call
84
Trading strategies
Bull Spread
X2
X1
ST
85
Trading strategies
Bull Spread long call with X1
X2
X1
ST
long call
86
Trading strategies
Bull Spread long call with X1 short call with
X2
X2
X1
ST
short call
87
Trading strategies
Bull Spread long call with X1 short call with
X2
X2
X1
ST
short call
long call
88
Trading strategies
Bull Spread long call with X1 short call with
X2
X2
X1
ST
short call
long call
89
Trading strategies
Bull Spread long call with X1 short call with
X2
X2
X1
ST
short call
long call
90
Trading strategies
Bull Spread long call with X1 short call with
X2
X2
X1
ST
short call
long call
91
Trading strategies
Bull Spread long call with X1 short call with
X2
X2
X1
ST
short call
long call
92
Trading strategies
Bear Spread
X2
X1
ST
93
Trading strategies
Bear Spread short call with X1
short call
X2
X1
ST
94
Trading strategies
Bear Spread short call with X1 long call with
X2
X2
X1
ST
long call
95
Trading strategies
Bear Spread short call with X1 long call with
X2
short call
X2
X1
ST
long call
96
Trading strategies
Bear Spread short call with X1 long call with
X2
short call
X2
X1
ST
long call
97
Trading strategies
Bear Spread short call with X1 long call with
X2
short call
X2
X1
ST
long call
98
Trading strategies
Bear Spread short call with X1 long call with
X2
short call
X2
X1
ST
long call
99
Trading strategies
Bear Spread short call with X1 long call with
X2
short call
X2
X1
ST
long call
100
American Put and Call
  • American-style Put and Calls are like European -
    style Puts and Calls with the only difference
    that American options can be exercised at ANY
    TIME before the time of maturity. Let denote this
    time TltT.
  • Added feature from the possibility of early
    exercise may not be worth too much because the
    option holder can resell the option on the
    exchange.

101
American Put and Call
  • First of all, American call is more expensive
    than European call and American put is more
    expensive than European put.
  • C gt c and P gt p
  • Why?
  • American style options can be exercised at any
    time before the date of maturitywhich means that
    they can be AT LEAST exercise the same day as
    European option is exercised.
  • Having American option gives you more freedom.
  • You have to pay for that!

102
Exotic Options
  • Bermudan Option - early exercise is restricted to
    certain dates during the life of option.
  • Forward Start Option - options that are paid for
    now but will start at some time in the future.
    Employee incentive scheme.
  • Compound Options - Options on Options.

103
Exotic Options
  • As You Like It Option - the holder can choose
    if option is call or put.
  • Barrier Option - the payoff depends on whether
    the exchange rate reaches a certain level during
    a certain period of time.
  • Cash-or-Nothing Option - pays off nothing is the
    stock price ends up above the strike price and
    pays off cash if it ends up above the strike
    price.

104
Exotic Options
  • Lookback Option - the payoff is the amount by
    which the maximum stock price achieved during the
    life of the option exceeds the final stock price.
  • Asian Options - the payoff depend on the average
    price of the underlying asset during the life of
    the option. Max(0,Save-X).
  • Rainbow Option - options involving two or more
    assets.
  • Russian Option - American option without
    expiration.

105
Policy matters
  • As with any derivatives market, a generic
    question is whether the existence of the option
    market leads to negative spillover effects, such
    as an increase in the volatility of the
    underlying asset.
  • A related public policy concern is the risk to
    which option traders are exposed and how the
    capital requirements for those risks should be
    measured.
About PowerShow.com