FX Derivatives

Forwards, Futures & Options

Phan Vũ Ngọc Lan

FORWARD

1
 Forward Transactions
• In the FX markets, spot transactions are settled within 2 business days. If
participants would like to buy or sell currencies for delivery at some
point in the future, they engage in forward transactions.
• A forward transaction is undertaken today, but it is settled anywhere
between 3 business days to 2 years into the future. The forward quote is
the rate at which currencies are exchanged in the future settlement date.
• These rates depending on the trading environment is quoted in two
different ways:
– Outright Quotation
– Swap Quotation or Forward Swap Points

Forward Quotations
Outright Forward Quote:
• Forward price is expressed as in spot, number of local
currency units per foreign currency
– Eg: 1 year Outright dollars per euro: EUR/USD1.3366-1.3374 or
EUR/USD1.3366/74
Swap Quotation or Forward Swap Points:
• Forward rates are often quoted in “Points” in reference to
spot rates
– Spot EUR/USD is 1.2016/17
– 1 year forward points: 29.60/28.75

2
 From Forward Points to Outright Forward

• If we are given “ forward points” we can calculate the

outright forward rate by:
– F=S+Forward Points
• Note that Forward/Swap points may be positive or negative.
In other words, depending of the sign of the swap points, we
either add or subtract swap points from bid /ask rates.
– Given swap points quotation of X/Y
– If X>Y swap points are treated as negative
– If X<Yswap points are treated as positive

One more important piece of information

• Depending on the spot quotation (i.e depending on the

decimal points in the spot quotation) swap points are divided
by 10,000 or 100.
• If the spot quote has four decimals as in EUR/USD spot
quotes, we divide the swap points by 10,000 before we add
or subtract them from spot bid and offer rates (depending on
the sign assigned to them).
• If the spot quote has 2 decimals as in EUR/JPY or USD/JPY,
swap points are divided by 100.

3
 From Forward Points to Outright Forward Rates
• Spot EUR/USD is 1.2016/17
– 1 year forward points: 29.60/28.75
– 29.60 means $0.002960 or 1/10,000 of the points
– 28.75 means $0.002875 or 1/10,000 of the points
– Since X=29.60>Y=28.75 Swap Points are negative
• Outright Bid: 1.2016-0.002960=1.1986
• Outright Offer: 1.2017-0.002875=1.1988
– Note that points expressed in the quotation divided by 10,000 (eg:
29.6/10,000=0.00296)
• 1 Year Outright Forward: 1.1986-1.1988 or 1.1986/88

Summary: Forward Swap Points

• Forward Outright=Spot+ Forward Swap Points

• Basic Rule:
– If bid swap point is >ask swap point subtract 1/10000 of the swap
points from bid and ask rates (swap points<0)
– If bid swap point is < ask swap point add 1/10000 of the swap points
to bid and ask rates (swap points>0)

4
 Example….
• USD/CAD Spot 1.4120/26
– 6-m forward Swap: 58/44
– 6-m forward outright bid: 1.4120-(58/10,000)=1.4062
– 6-m forward outright offer:1.4126-(44/10000)=1.4082

• EUR/USD 1.4320-1.4325
– 1 yr forward swap points: 20/25
– 1 yr outright forward bid  1.4320+0.0020 =1.4340
– 1yr outright forward offer 1.4325+0.0025=1.4345

Mid-rate

• In some cases instead of bid and offer rates, we use an

average of these two. Mid rates are used to make general
statements about exchange rates.
• For instance, daily or weekly changes in exchange rates are
often calculated by using mid rates.
• These are not very useful in trading currencies, but it is good
to know what we mean by mid-points.

10

5
 Example: Forward Bid/Offer Rates

Spot exchange rate:

Bid rate (SF/$) 1.2575

Ask rate (SF/$ 1.2585

One-month forward 10 to 15
3-months forward 14 to 22
6-months forward 20 to 30

1-m forward bid rate : 1.2575+0.0010=1.2585

1-m forward offer rate: 1.2585+0.0015=1.2600
1-month forward mid-rate= (1.2585+1.2600)/2=1.2593

3-m forward bid rate : 1.2575+0.0014=1.2589

3-m forward offer rate: 1.2585+0.0022=1.2607
3-month forward mid-rate= (1.2589+1.2607)/2=1.2598

11

An Exception: JPY
• Since JPY is expressed with only two decimal points, the
swap points in JPY should be divided into 100 rather than
10,000.
• Example: Spot Rate: 92.30-92.50
– 3-months Swap Point: 45/44

• Outright Forward Rates:

– Bid: 92.30-0.45=91.85
– Offer92.50-0.44=92.06
– Note that the spread is slightly larger for the 3-m forward rate.

12

6
 Forward Premium or Discount

• Forward rates maybe larger or smaller than the spot rates

depending on the relative interest rates.
• If F>S, the base currency has a forward premium
– We can also interpret this as base currency is worth more in forward
relative to spot rate

• F<S, the base currency has a forward discount

– We can also interpret this as base currency is worth less in forward
relative to spot rate

13

Forward Premium/Discount of the Base Currency

F0,T -S0 360

Forward Premium/Discount= ( )
S0 d

Note that Forward rate has maturity T at time 0.

Forward Premium or Discount is annualized with the
Factor (360/d) where d=number of days forward.

Alternatively we can use (12/m)

where m= months in forward

14

7
 Forward Premium/Discount of the Terms Currency

S0 -F0,T 360
Forward Premium/Discount= ( )
F0,T d

Note that Forward rate has maturity T at time 0.

Forward Premium or Discount is annualized with the
Factor (360/d).

15

Forward Premium and Discounts

¥/$ ¥/$ Calculated

Period Days Forward Bid Rate Ask Rate Mid-Rate
spot 114.23 114.27 114.25000
1 month 30 113.82 113.87 113.84500
2 months 60 113.49 113.52 113.50500
3 months 90 113.05 113.11 113.08000
6 months 180 112.05 112.11 112.08000
12 months 360 110.20 110.27 110.23500
24 months 720 106.83 106.98 106.90500

6 month forward premium or discount of US (Base/Foreign Currency):

F-S/S x(360/180)=[(112.08-114.250)/114.250]x(360/180)=
=-3.799% (US dollar at 3.799% discount )

6 month forward premium or discount of JPY (Terms/Local Currency):

S-F/F x(360/180)=[(114.250-112.08)/112.08] x (360/180)
=3.872% (JPY is at 3.87% premium)

16

8
 Exercise 1: Forward Premium and Discounts

¥/$ ¥/$ Calculated

Period Days Forward Bid Rate Ask Rate Mid-Rate
spot 114.23 114.27 114.25000
1 month 30 113.82 113.87 113.84500
2 months 60 113.49 113.52 113.50500
3 months 90 113.05 113.11 113.08000
6 months 180 112.05 112.11 112.08000
12 months 360 110.20 110.27 110.23500
24 months 720 106.83 106.98 106.90500

a/ 12 month forward premium or discount of US (Base/Foreign Currency)?

b/ 12 month forward premium or discount of JPY (Terms/Local Currency)?

17

Currency Forwards: Definition

• An agreement to exchange a given amount of currency at

a predetermined fixed rate at a specified future date.
• Forward contracts are customized in terms of amounts and
maturities.

21

9
 Characteristics
• It is an OTC product ( over the counter market )
• Its maturity typically ranges from 3 days to 1 year, but
longer maturities may be available
• Forward contracts are zero cost contracts (i.e. value of
the contract at inception is zero)
• In a forward contract there is only one cash flow and it
takes place at the maturity!!

22

Advantages and Disadvantages of Forwards

• Advantages • Disadvantages
– Simple – Lack of liquidity
– One cash flow – Credit risk
– Widely available – No flexibility; does not allow
to take advantage of
– Easily customized for
favorable movements
specific needs
– Zero cost

23

10
 • Forward rate (F)
• Forward date.
• Spot date.
• Spot Rate ( S)
• Forward point (p)
– P=F -S

Contract Signal Contract Date Settlement date

Spot S To To+2
Forward Ft To ( Term t) T0+t + 2

24

Example

• You have EUR5,000,000 receivable due in one year.

• Spot EUR/USD is 1.3176/77
(read $1.3176-1.3177 per Euro)
• 1 year forward quote is given as:
– $1.3366-1.3374

• Assume that you locked into 1 year forward rate!

25

11
 Forward Contract

• Note that you are selling euro, hence you will trade at bid
rate of 1.3366.
• The transaction requires you to deliver 5,000,000 euros in
exchange for $6,683,000
• The transaction settles 1 year after spot value date (spot
value date: T+2)

26

$ Value of Euro Receivable

Spot Rates
Cash Flows

$ 1.2000 $ 1.3000 $ 1.4000

Without Forward
$ 6,000,000 $ 6,500,000 $ 7,000,000
(Unhedged)

With Forward (Hedged) $ 6,683,000 $ 6,683,000 $ 6,683,000

Hedging Gain (Loss) $ 683,000 $ 183,000 $ (317,000)

1 year forward quote is given as:

$1.3366-1.3374

27

12
 Yellow dashed line shows $ received in the forward contract

Net USD Cash Flows with Forward Contract

$7,200,000

$7,000,000

$6,800,000 $6,683,000 Hedging Loss

$6,600,000

Hedging Gain
$6,400,000

$6,200,000
$1.3366

$6,000,000

28

Forward Quotations

Outright Forward Quote:

• Forward price is expressed as in spot, number of local
currency units per foreign currency
– Eg: 1 year Outright dollars per euro: EUR/USD1.3366-1.3374 or
EUR/USD1.3366/74
Forward Swap Points:
• Forward rates are often quoted in “Points” (interest rate
differential multiplied with spot rate) in reference to spot
rates:
– Spot EUR/USD is 1.2016/17
– 1 year forward points: 29.60/28.75

29

13
 From Forward Points to Outright Forward

• Forward Points are positive or negative numbers added to

the spot to calculate the outright forward rate. In this
example:
– Outright Bid: 1.2016-0.002960=1.1986
– Outright Offer: 1.2017-0.002875=1.1988
• Note that points expressed in the quotation divided by
10,000 (eg: 29.6/10,000=0.00296)
• 1 Year Outright Forward: 1.1986/88

30

Forward Swap Points

• Forward Outright=Spot+ Forward Swap Points

• Basic Rule:
– If bid swap point is >ask swap point deduct 1/10000 of
the swap points from bid and ask rates (swap points<0)
(Discount Spread)
– If bid swap point is < ask swap point add 1/10000 of
the swap points to bid and ask rates (swap points>0)
(premium spread)

31

14
 Example….

• USD/CAD Spot 1.4120/26

– 6-m forward Swap: 58/44

• 6 month Outright Forward

– Bid: 1.4120-(58/10,000)=1.4062
– Ask:1.4126-(44/10,000)=1.4082

32

• Spot: USD/JPY122.10/122.15
– 6-m forward Swap: 30/40
– 6 month Outright Forward
• Bid =122.10 + 30/100 = 122.40
• Ask = 122.15 + 40/100 = 122.55

33

15
 • HOW TO SET THE FORWARD RATE!!

34

Forward Rate is not a Forecast

• Consistent and accurate FX forecast/prediction is next to

impossible!
• Then how can anybody quote a rate that will be the basis of
exchange in the future!

35

16
 Example: Bid Rate

• A US exporter wants to sell its 1 million GBP receivables

due in one year forward. The cash flow is expected exactly
one year from now. The exporter calls the XYZ-BANK and
inquire a forward quote. It takes only a few seconds to
provide the quote. The quote calculation and reasoning
behind is as follows:

36

Spot and Interest Rates

Spot : 1.6050-1.6090
Money Market Rates
RUS 5.00-6.00%
RUK 10.00-12.00%

37

17
 Step by Step Logic of Pricing

• The exporter will deliver GBP 1m 1 year from now

and receive USD from XYZ. XYZ needs to
determine the appropriate amount of USD it can pay
in exchange for GBP 1m.
• Since XYZ will receive 1m GBP, it will have a
long position in GBP. XYZ can offset this position
by borrowing present value of this amount, i.e.
GBP1m/1.12=892,857.14 (XYZ now owes 1m
GBP 1 year from now).

38

• Sell GBP 892,857.14 @spot 1.6050 and receive

USD1,433,035
• Deposit this amount @5% for one year (will grow to
1,504,687).
• 1 year from now XYZ will have
– 1,000,000 GBP receipt from the exporter
– 1,000,000 GBP owes to another bank
– 1,504,687 USD in the bank account

• XYZ can pay the exporter 1,504,687 or less in exchange for

GBP 1m.
• XYZ could quote GBP/USD 1.5046 as a forward rate.

39

18
 Example: Offer Rate

• A US importer wants to buy 1 million GBP to cover

its accounts payable due in one year forward. The
cash flow is expected exactly one year from now.
The exporter calls the XYZ office and asks for a
forward quote. The quote and reasoning is as
follows:

40

Spot and Interest Rates

Spot : 1.6050-1.6090
Money Market Rates
RUS 5.00-6.00%
RUK 10.00-12.00%

41

19
 • XYZ needs GBP 1m 1 year from now for delivery.
• If it had x amount of GBP it could grow @10%.
• 1m /1.1= 909,091 GBP now would grow to 1m GBP at the
time of delivery
• To buy 909,091 GBP @1.6090= $1.462,727 is needed
• XYZ borrows this amount at the market rate of 6%.
• At the time of delivery it will owe 1.462,727 * (1+0.06) = $
1,550,491
• XYZ uses 1,462,727 to buy 909,091 and deposit this amount
at 10%.

42

• One year from now XYZ will have

– 1,000,000 GBP in bank deposit
– 1,550,491 USD liability
– 1,000,000 GBP commitment to the customer

• If XYZ collects 1,550,491 from the customer in

exchange for GBP 1m, it will break even.
• XYZ may quote 1.5505 or more for each pound it
delivers.

43

20
 Forward Bid/Offer Rates

(1  R d , Bid )
F Bid
 S Bid
(1  R f ,Offer )

(1  R d ,Offer )
F Offer
 S Offer
(1  R f , Bid )

44

• Giả sử tỷ giá giao ngay (spot rate) • => F =FVd/FVf

=
– PVf = PVd (1 USD =..VND) PVd (1+Rd t)
– S= PVd / PVf (USD.VND) PVf (1 +Rf t)
=
• Giả sử tỷ giá Kỳ hạn (Forward rate) (1+Rd t)
S* (1 +Rf t)
– FVf= FVd (1 USD=… VND future)
– F= FVd/FVf
• Áp dung công thức giá trị thời gian tiền
tệ ( time value of money).
• FVd= PVd (1+Rd *t)
• FVf = PVf (1 +Rf *t)
45

21
 Example

• Spot: USD/JPY122.10/122.15
• (read as JPY per $)
• 3-months Money market rates
– RJapan=1.25-1.50 pa
– RUS= 5.50-5.75 pa

46

Forward Bid/Offer Rates

• 3-m Forward Bid:

(1  (0.0125  (90 / 360)))
F Bid
 122.10
(1  (0.0575  (90 / 360)))
 120.74

• 3-m Forward Offer

90
1 + 0.0150
360
= 122.15 = 120.94
90
1 + 0.0550
360

47

22
 Forward/Swap Points
Swap Point=(Forward Rate)-(Spot Rate)

(Rd  R f )
Forward (Swap) Points = Spot 
(1  R f )

(0.0125(90/360)) (0.0575(90/360))
SP(Bid) 122.10 1.3541
(1(0.0575(90/360 )))

(0.015(90/360))  (0.055(90/360))
SP(Offer) 122.15 1.2049
(1 (0.055(90/360 )))

48

Exercise-2

• Suppose you work for Citicorp Czech Republic. A local

bank wanted to buy USD 50,000,000 one month forward.
Current spot and one month interest rates in USD and Czech
Koruna are as follows:
– USD/CZK 21.10-21.80
– RUSD: 3.50-4.50 p.a. (these interest rates are annualized)
– RCZK: 7.00-8.00% p.a. (these interest rates are annualized)

• 1/ Show your step by step of logic pricing to calculate your

forward quote.
• 2/ Using the formula given to calculate your forward quote
bid & ask.

49

23
 Exercise-3
• The following spot and interest rates are observed in the market:
– EUR/USD1.4910-1.4940
– R-USD-3-months: 1.50%-2.00% pa
– R-EUR-3-months: 3.50%-4.50% pa

• Assume that you are a banker who has access to the above rates.
• a/ Using the formula given, what EUR/USD rate would you quote
for an importer who is interested hedging its EUR100m cash
ouflows due in three months?
• b/ Using the formula given, what EUR/USD rate would you quote
for an exporter who is interested hedging its EUR100m cash
inflows due in three months?

55

Non-Deliverable Forwards

• Non-deliverable forwards (NDFs) operate very much like

traditional forward contracts with the exception that there is
no physical delivery of funds.
• Instead, the contract is cash-settled in USD or in another
major currency such as EUR at expiration.
• To a certain extent, NDFs offer the same hedging and
investment capabilities as that of a traditional forward
contract.

56

24
 • Their existence makes it possible for offshore participants to
manage the currency risk of doing business in a number of
developing economies, even where there is little or no direct
access to the local currency market.

57

NDFs are available for…

58

25
 Example

• Suppose USA Inc. was set to receive 300 million Korean

won in 3 months time.
• The company decides to hedge its exposure with a non-
deliverable forward (NDF).
• The contract specifications are as follows:

59

Contract Specs

Contract Date 9/2/xx

Current Spot rate 905.00
3M Forward Rate 1065.00
FC Amount Sold KRW 300,000,000
USD bought $281,690

60

26
 NDF Rule

• This means that USA inc. has assured themselves a USD

value of $281,690 for their forthcoming receivable.
• However, because this is not a traditional forward contract,
USA Inc. will not deliver the 300 million KRW to the bank.
• Instead, at contract expiry, they will sell the Won on the spot
market. Any gains or losses incurred relative to the execution
rate of 1065.00 will be USD cash-settled between USA Inc.
and the bank.

61

NDF Settlement

• Suppose that the USD/KRW spot rate at contract expiry is

KRW1188.00/$. USA inc. will conduct the following two
transaction

• In this case, only the difference between the spot rate and the
agreed upon forward rate is settled. USA Inc. receives
$29,165 from the bank!

62

27
 • THE END

63

28