Why Gold Prices Fluctuate?This is the first post in the learner's series. A simple question that we will answer through this p...
Lessons
- CFA Level 2: Derivatives Part 1 – Introduction
- What are Forward Contracts?
- Equity Forward Contracts
- Fixed Income Forward Contracts
- Currency Forward Contracts
- Forward Rate Agreements (FRA)
- Credit Risk and Forward Contracts
- Introduction to Futures Contracts
- Futures: Convergence of Spot and Futures Prices at Expiration
- Futures Prices vs. Forward Prices
- Contago and Backwardation
- Pricing Stock Index Futures
- Pricing Interest Rate/Treasury Bond Futures
- Pricing Currency Futures
- Eurodollar Futures
Pricing Currency Futures
- Currency futures are priced in the same manner as currency forward contracts.
- Price of a Currency Future with Simple Compounding:
f(0,T)X/Y = S0,X/Y ((1+rX)/(1+rY))T
T = total contract length
S0 = Spot exchange rate for X/Y (#X units domestic per 1Y foreign) at initiation
rX = Risk free rate in country X (domestic currency)
rY = Risk free rate in country Y (foreign currency)
Price of a Currency Future with Continuous Compounding
f(0,T)X/Y = (S0,X/Y e-ryT ) erxT
- If the currency future is not "fairly" priced (i.e. not priced based on an arbitrage relationship based on risk free rates), then it is possible for a trader to earn a risk-free arbitrage profit.
- Futures Market Overvalues a Currency:
- Sell the overvalued futures contract
- Buy the underlying currency in the spot market
- Borrow and invest all cash flows
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