Microsoft Word - Money, Banking, and Int Finance(scribd).docx

Money, Banking, and International Finance

Exxon loses on the futures contract because it must pay one million U.S. dollars to pay its
contract in Malaysia. If a speculator bought this contract from the Malaysian bank, then he or
she loses approximately $250,000 on this contract if the contract matured today. Malaysian bank
profits by buying 3 million ringgits for $750,000 and selling them for $1 million to Exxon.
Who pays the margin if the exchange rate changes to $1 = 2 ringgits? Ringgits appreciated
while the U.S. dollar depreciated. The Malaysian bank must deposit money into a margin
account. In this case, Exxon benefits from the exchange rate because its ringgit contract has
appreciated. Easy way to determine whom benefits is to convert the ringgits into U.S. dollars for
both the spot and futures market. We calculate spot transaction in Equation 3 and the futures
transaction in Equation 4.

Spot market: 1 , 500 , 000

2

1

3,000 000 =$

rm

$

, rm (3)

Futures market: 1 , 000 , 000

3

1

3,000 000 =$

rm

$

, rm (4)

Exxon gains from the derivatives contract because it pays one million U.S. dollars.
However, if Exxon exchanged its U.S. dollars on the spot market, then Exxon would exchange
one and a half-million U.S. dollars pay its ringgit contract in Malaysia. For this case, a
speculator could earn a profit of a half-million U.S. dollars if the futures contract matured today.
Speculator buys 3 million ringgits for $1 million and sells them for $1.5 million.

Options Contract

Options contract represents the second class of derivatives. Options contract differs from a
futures contract because the option holder has the choice to buy or sell an asset. For example,
you entered into an options contract, giving you the right to buy petroleum for $80 per barrel in
6 months. On the day of delivery, if the price of oil equals $70 per barrel, you do not exercise
the options contract. That is your option! If oil is $90 per barrel on the day of delivery, then you
will exercise your options contract. Investor who sold you this contract must sell the oil for $80
per barrel to you. Options contracts are defined as either call or put options. Call option gives
the holder the right to buy an asset for a specific price in the future. On the other hand, the put
option gives the holder the right to sell an asset for a specific price in the future.
All options have an exercise or strike price; the price listed on the option. Option has an
expiration date, which is the date the right to buy or sell expires. Furthermore, options are either
American or European. American options allow the option holder to exercise the option any
time before the expiration date, while the European options restrict the right to exercise the
option on the expiration date. Furthermore, options are not free. Option holders must pay a fee,
called the option premium. Calculating premiums and exercising options are different between
American and European options. Keeping the chapter simple, we use the European options for
all examples.