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Foreign Exchange Options





Foreign Exchange Swaps

Swaps are transactions in which two parties swap financial assets by linking a foreign exchange transaction in cash to an opposite futures business in the same currency.

Foreign Exchange Swap Markets have developed since the early 1980s. The oldest type of swap is the conventional foreign exchange deal whereby one currency is simultaneously bought spot and sold forward against another – meaning an immediate exchange of cash followed by a further reverse exchange at a specified date in the future.

The idea of swapping has now spread further. By far the largest business volume amongst swaps occurs n the so-called "vanilla interest rate swap". A "plain vanilla", or fixed-to-fixed foreign exchange, or currency swap is аn exchange of the principal and interest payments associated with a fixed-rate loan in one currency for the principal and interest payments on a similar loan in a second currency. The first such swap between IBM and the World Bank was done in 1981. Since then the swap market has grown to over $ 1 billion and, in the process, has evolved several additional types of currency swaps.

Words you may need:

Foreign Exchange Swap – валютний „своп”

to buy spot – придбати на умовах „спот”

followed by – за яким слідує ...

vanilla interest rate swap – „своп” процентний

plain vanilla – простий процентний „своп”

evolve – розвиватись, еволюціонувати

 

4. Read the text quickly to find answers to the following questions:

· What does the price of a foreign exchange option depend on?

· What are the prospects for the option markets?

Options as a fiinancial instrument have a reasonably short history in financial markets, with the first option contracts being traded in Chicago in 1973. In foreign exchange, a call option on the US dollar is the right to buy the US dollar, and a put option is the right to sell the US dollar. To purchase an option, the buyer has to pay a premium. Тo write an option, the seller receives a premium.



There are three different types of users of foreign exchange options: the corporate treasury, the fund manager, and the commercial bank trading room. For example, in the currency option markets, the corporate treasury can buy the right, but not the obligation, to sell or buy currency forward, if required. This option, to decide whether to buy or sell currency, is particularly important when the firm is unsure about the timing or size of foreign currency receipts or payment.

International banks, in their turn, use currency options for their customers and for their own trading. In the past few years, nearly all dealing rooms have seen a large growth in the use of currency options and banks have started employing traders purely to trade currency options for the bank's own account.

Options are also sold "over the counter" (OTC) in a manner similar to currency forward contracts. OTC contracts have very flexible terms arranged by negotiation between the (normal bank) supplier and corporate buyer. Thus the currencies to be bought and sold can vary according to the corporate customer's needs and do not have to correspond to exchange market conventions. Amounts, duration of the option, and price can all be negotiated and matched to the corporate customers' exposure.

The volume of trading on the OTC market between banks is even higher than on the listed options market. There is no public secondary market in OTC currency options but trading is conducted by telephone using prices available on screen systems provided by large international (commercial and investment) banks. MNCs are major users of OTC options and are key participants in the screen markets. These OTC markets are closely linked to spot and forward markets in currency in which the banks and MNCs also play central roles.

The organized currency option exchanges provide an important public pricing mechanism for the MNC treasurer and may also provide a suitable currency option contract for foreign cash flows of known size but uncertain likelihood of occurrence.

The price of a foreign exchange option depends on: the length of a period desired to be covered by the option; the underlying volatility of the foreign exchange market; the relationship between the spot exchange rate and the desired price or the desired strike price; option premium; foreign interest rate.

Moreover, the type of currency option that financial institutions, corporations and the like can trade in vary from the extremely simple to the very sophisticated. It is possible to design tailor-made foreign exchange options to suit requirements, as essentially a foreign exchange option is akin to an insurance premium on the foreign exchange market. All this makes this instrument very attractive.

Within the past fifteen years the use of options has grown in all financial markets. It seems quite likely that foreign exchange options will grow further in coming years.

 

Words you may need:

call option – опціон „кол”

put option – опціон „пут”

to write an option – виконати опціон

corporate treasury – підрозділ у корпорації що займається управлінням її вільними коштами

to sell (buy) forward – продати (купити) на термін

convention – конвенція, договір

strike price – ціна виконання

and the like – і тому подібне

tailor-made – з врахуванням потреб замовника

to be akin (to) – бути близьким (чому-небудь)

 

 

žTESTS

I. Choose the correct answer:

1.Exchange of currencies is possible if national currencies are:

a) changeable;

b) interchangeable;

c) not changeable.

 

2.The terms on which one currency will exchange against another are referred to as:

a) currency exchange;

b) unit of exchange;

c) rate of exchange.

 

3.Trading in the Foreign Exchange Market occurs:

a) 6 hours a day;

b) 12 hours a day;

c) 24 hours a day.

 

4.The Foreign Exchange Market consists of:

a) two major sectors;



b) three major sectors;

c) four major sectors.

 

5.More than half of all transactions in the Market are:

a) futures deals;

b) forward deals;

c) spot deals.

 

II. Match what statements are true and what are false. Results write to the table:

1. Exchange of currencies is possible if national currencies are not changeable.

2. The Foreign Exchange Market is the oldest financial market in existence.

3. Deals in the Market are concluded over telecommunications networks by different counterparties.

4. The exchange market has a centralized location.

5. The cost of transacting in the wholesale market is reflected in the bid-offer spread.

6. As prices are different in different markets, professional dealers may take advantage of it buying.

Table

 
True            
False            

 


ì Unit 8

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