EECS 3101 Lecture Notes - Lecture 38: Futures Contract, Spot Contract, Pound Sterling
28 Jun 2018
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EECS 3101 Lecture 38 Notes
Introduction
Credit Risk of Currency Futures Contracts
If a currency’s spot and futures prices were the same and if the currency’s interest rate
were higher than the U.S. rate, then U.S. speculators could lock in a higher return than
they would receive on U.S. investments.
They could purchase the foreign currency at the spot rate, invest the funds at the
attractive interest rate, and simultaneously sell currency futures to lock in the exchange
rate at which they could reconvert the currency back to dollars.
If the spot and futures rates were the same, then there could be neither a gain nor a
loss on the currency conversion.
Therefore, the higher foreign interest rate would yield a higher return with this type of
investment.
The actions of investors to capitalize on this opportunity would place upward pressure
on the spot rate and downward pressure on the currency futures price, causing the
futures price to fall below the spot rate.
Each currency futures contract represents an agreement between a client and the
exchange clearinghouse, even though the exchange has not taken a position.
To illustrate, assume you call a broker to request the purchase of a British pound futures
contract with a March settlement date.
Meanwhile, another person unrelated to you calls a broker to request the sale of a
similar futures contract.
Neither party needs to worry about the credit risk of the counterparty.
In other words, participants must make a deposit with their respective brokerage firms
when taking a position.
The exchange clearinghouse assures that you will receive whatever is owed to you as a
result of your currency futures position.
Document Summary
If a currency"s spot and futures prices were the same and if the currency"s interest rate were higher than the u. s. rate, then u. s. speculators could lock in a higher return than they would receive on u. s. investments. In other words, participants must make a deposit with their respective brokerage firms when taking a position. The exchange clearinghouse assures that you will receive whatever is owed to you as a result of your currency futures position. A currency"s spot and futures prices were the same and if the currency"s interest rate were higher than the u. s. rate, then u. s. speculators could lock in a higher return than they would receive on u. s. investments. If the spot and futures rates were the same, then there could be neither a gain nor a loss on the currency conversion. Therefore, the higher foreign interest rate would yield a higher return with this type of investment.
