International Finance: Putting Theory Into Practice

224 CHAPTER 6. THE MARKET FOR CURRENCY FUTURES

Table 6.1: Forward Contracts with Variable Collateral or Daily Recon-
tracting

data Variable Collateral Periodic Recontracting

time 0:

F 0 , 3 = 40

r 0 , 3 = 3%

Smitha buys forward usd 1m at

F 0 , 3 = 40

Smitha buys forward usd 1m at

F 0 , 3 = 40

time 1:

F 1 , 3 = 38

r 1 , 3 = 2%

Market value of old contract is

38 m 1 −. 0240 m=− 1. 961 m

Smitha puts up T-bills worth

at least 1.961m

Market value of old contract is

38 m 1 −. 0240 m=− 1. 961 m

Smitha buys back the old con-

tract for 1.961m and signs a new

contract atF 1 , 3 = 38.

time 2:

F 1 , 3 = 36

r 2 , 3 = 1%

Market value of old contract is

36 m 1 −. 0140 m=− 3. 960 m

Smitha increases the T-bills

put up to at least 3.960m

Market value of old contract is

36 m 1 −. 0138 m=− 1. 980 m

Smitha buys back the old con-

tract for 1.980m and signs a new

contract atF 2 , 3 = 36.

time 3:

F 3 , 3 =S 3 = 34

r 3 , 3 = 0%

Smitha pays the promisedinr40m

for theusd1m, and gets back her

T-bills

Smitha pays the promisedinr36m

for theusd1m

total paid: inr40m (adjusted for time value:)

• time 3: 36m


• time 2: 1.980×1.01= 2m


• time 1: 1.961×1.02= 2m


• total: 40m

DoItYourself problem 6.1
Given a sequence{F 1 , 4 , F 2 , 4 , F 3 , 4 , F 4 , 4 =S 4 }, write in algebra the cash flows from
daily recontracting, and show that if all losses are financed by loans and all gains
are deposited until timeT= 4, you pay, all in all,F 1 , 4.

The system of variable collateral is used in many stock exchanges in continental
Europe. Somewhat confusingly, these contracts are sometimes called futures con-
tracts; in reality, they are collateralized forward contracts. “Futures” just sounds
cooler than forwards, though.

This finishes our discussion of credit risks in forward contracts. We now see how
this is handled in futures markets, and how secondary dealing has been organized.