The Survey of North American Foreign Exchange Volume is designed to measure the level of turnover in the foreign exchange market. The survey defines foreign exchange transactions as spot, forwards, swaps, and options that involve the exchange of two currencies. Turnover is defined as the gross value in U. The data cover a one-month period in order to reduce the likelihood that very short-term variations in activity might distort the data.
Turnover is measured in terms of nominal or notional amount of the contracts. Nondollar amounts are converted using the prevailing exchange rate on the transaction date. Direct cross-currency transactions are counted as a single transaction. Transactions with variable nominal or notional principal amounts are reported using the principal amount on the transaction date. The data collected for the survey reflect all transactions entered into during the reporting month, regardless of whether delivery or settlement is made during the month.
Average daily turnover was obtained by dividing the total volume by the number of trading days in the month. There were twenty-one reporting dealers in the October survey. The survey covers all transactions that are priced or facilitated by traders in North America United States, Canada, and Mexico. Transactions concluded by dealers outside of North America are excluded even if they are booked to an office within North America.
The survey also excludes transactions between branches, subsidiaries, affiliates, and trading desks of the same firm. The survey is divided into separate schedules by product type.
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If a transaction is composed of several component instruments, each part in principle is reported separately, if feasible. Spot Transactions are single outright transactions that involve the exchange of two currencies at a rate agreed to on the date of the contract for value or delivery within two business days, including U. However, the amount is rarely significant and, hence, it will be ignored in this article. Notes: 1.
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Alternatively, the underhedged amount could be hedged on the forward market. This has not been considered here as the underhedged amount is relatively small. For simplicity it has been assumed that the options have been exercised. However, as the transaction date is prior to the maturity date of the options the company would in reality sell the options back to the market and thereby benefit from both the intrinsic and time value of the option.
By exercising they only benefit from the intrinsic value.
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Hence, the fact that American options can be exercised at any time up to their maturity date gives them no real benefit over European options, which can only be exercised on the maturity date, so long as the options are tradable in active markets. The exception perhaps is traded equity options where exercising prior to maturity may give the rights to upcoming dividends. Much of the above is also essential basic knowledge. You are unlikely to be given the spot rate on the transaction date. However, the future spot rate can be assumed to equal the forward rate which is likely to be given in the exam.
The ability to do this may earn up to six marks in the exam. Equally, another one or two marks could be earned for reasonable advice. This article will now focus on other terminology associated with foreign exchange options and options and risk management generally. All too often students neglect these as they focus their efforts on learning the basic computations required.
However, knowledge of them would help students understand the computations better and is essential knowledge if entering into a discussion regarding options. For instance, if you own shares in a company you have a long position as you presumably believe the shares will rise in value in the future. You are said to be long in that company. You are said to be short in that company. To create an effective hedge, the company must create the opposite position. This has been achieved as, within the hedge, put options were purchased.
Therefore, the position taken in the hedge is opposite to the underlying position and, in this way, the risk associated with the underlying position is largely eliminated. However, the premium payable can make this strategy expensive. It is easy to become confused with option terminology. For instance, you may have learnt that the buyer of an option is in a long position and the seller of an option is in a short position. However, an option buyer is said to be long because they believe that the value of the option itself will rise.
The hedge ratio equals N d 1 , which is known as delta. Students should be familiar with N d 1 from their studies of the Black-Scholes option pricing model. What students may not be aware of is that a variant of the Black-Scholes model the Grabbe variant — which is no longer examinable can be used to value currency options and, hence, N d 1 or the hedge ratio can also be calculated for currency options.
This information can be used to provide a better estimate of the number of options the company should use to hedge their position, such that any loss in the spot market is more exactly matched by the gain on the options:. This article has revisited some of the basic calculations required for foreign exchange futures and options questions using real market data, and has additionally considered some other key issues and terminology in order to further build knowledge and confidence in this area.
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Foreign exchange futures — the basics Scenario Imagine it is 10 July. Setting up the hedge Date? As the expected transaction date is 26 August, the September futures which mature at the end of September will be chosen. How many contracts?
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This conversion will be done using the chosen futures price. Hence, the total gain could be calculated in the following way: 0.
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Summary All of the above is essential basic knowledge. Foreign exchange futures — other issues Initial margin When a futures hedge is set up the market is concerned that the party opening a position by buying or selling futures will not be able to cover any losses that may arise. Marking to market In the scenario given above, the gain was worked out in total on the transaction date. At the end of the next trading day Monday 14 July , a similar calculation would be performed:.
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Maintenance margin, variation margin and margin calls Having set up the hedge and paid the initial margin into their margin account with their broker, the company may be required to pay in extra amounts to maintain a suitably large deposit to protect the market from losses the company may incur. Foreign exchange options — the basics Scenario Imagine that today is the 30 July.
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The choice is made in the same way as relevant futures contracts are chosen.