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richer1983

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发表于 2011-7-13 13:51 | 只看该作者

Currency Forward Contract

parties, purpose, entering, referring, contract
Why must a compensation be made to the party that was disadvantaged by the contract? Doesn't that defeat the purpose of entering into a contract since both parties are not as well off we before?

Was referring to page 172 of Schweser Book 5.

Thanks.
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Jolyn

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发表于 2011-7-13 13:51 | 只看该作者
In the example, Gemco is the short. Let's say the other company is Company X. Company X wants to buy these 50 million Euros in 3 months, so they are long the contract. Gemco is going to receive payment today for these Euros; they are the short.

Today, the rate is EUR/USD 1.23, giving Gemco a payment of $61.5M
In 3 months, the rate will be EUR/USD 1.25.

The EUR appreciated and the $ depreciated in value. So, in 90 days when the settlement date comes, the short, Gemco, will deliver the 50 million Euros per the contract. Because the x-rate is now 1.25, Gemco must deliver this additional $1M to Company X.

Imagine the situation the other way. If the x-rate had falled to 1.21, Gemco, the short, would receive $1M. They receive this amount because Company X, purchases the EUR from Gemco for a rate of 1.23, the contract rate, but the currency is now trading at 1.21.

I hope I was able to clear it up a little bit.



Edited 1 time(s). Last edit at Monday, August 3, 2009 at 02:39PM by kevin.venanzi.

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farrukhsadiq

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3#
发表于 2011-7-13 13:51 | 只看该作者
Shouldn't it be USD/EUR instead?

With the contract, Gemco was disadvantaged because he could have netted US$62.5M instead of the US$61.5M. I thought he should be the one being compensated?

Thanks.

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dotamasta

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4#
发表于 2011-7-13 13:51 | 只看该作者
revenant Wrote:
-------------------------------------------------------
> Shouldn't it be USD/EUR instead?
>
> With the contract, Gemco was disadvantaged because
> he could have netted US$62.5M instead of the
> US$61.5M. I thought he should be the one being
> compensated?
>
> Thanks.


It's EUR/USD. Currency pairs are quoted as one unit of the base currency, in this case it's Euro's, being equivalent to the x-rate in terms of the 2nd currency. You can read it as "1 Euro is worth $1.23."

Gemco entered the contract as a short because they thought that rates would fall in the future. If they fell, then Gemco would have received the payment as in the reverse situation at the end of my last post. If Gemco thought that rates would rise, it would not be in their best interest to enter the contract on the short side as they could receive more in the future without it.

Company X entered the contract long because they thought that rates would rise in the future, as they did. Opposite of the above statement, because rates rose, the long is disadvantaged because the current market rate at settlement is 1.25, while they only paid Gemco based on the 1.23 rate. Because the rates rose in their favor, they are to receive the payment. Once they receive the payment, they are no longer disadvantaged.

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amqata

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5#
发表于 2011-7-13 13:51 | 只看该作者
The idea behind getting into a forward contract is to hedge a preexisting risk. Gemco expects to receive EUR 50 million, and it wants to lock in an exchange rate of USD 1.23/EUR by entering into a forward. At the expiration of the forward, Gemco is more or less guaranteed that it will receive USD 61.5m (50*1.23).

Bottom line: Gemco has effectively locked in a receipt of $61.5m, and the counterparty has locked in a payment of USD $61.5m.

Notice that it the parties had not entered the forward contract Gemco would be exposed to the risk that the dollar would appreciate (euro depreciate) and the counterparty would be exposed to the risk that the Euro would appreciate (dollar depreciate).

As it turns out, the market exchange rate at settlement is USD 1.25/EUR (EUR has appreciated).

Gemco would receive $62.5 m from the market for its 50m Euros. On the forward contract, since it had sold Euros, it loses $1 m. The net outcome for Gemco is a net inflow of $61.5 million.

The sentence in Schweser that begins with "The counterparty would...." is extremely confusing and rather redundant. What it means is that Gemco would have benefited by $1m if it HADN'T entered the forward, and the counterparty would have lost a further $1m if it HADN'T gotten into the contract.

In your post you ask "Why must a compensation be made to the party that was disadvantaged by the contract?" This is an incorrect statement. The compensation must be made to the party that would be disadvantaged had they NOT entered the forward contract.

On an UNHEDGED position Gemco would be able to exchange its Euros for US 62.5m, and the counterparty would have to pay out $62.5m.

Hope this clears it all up!

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ftwcfa

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6#
发表于 2011-7-13 13:51 | 只看该作者
I dont have the example infront of me, but easiest way of attempting Currency Forward settlement payoffs is:

1. You have the forward contract.
2. On the settlement day, ask this question. Are you (GEMCO) better off without the contract?
3. If you are better off without the contract, then it is you who is paying.
4. If you are NOT better off wiithout the contract, then it is you who is receiving.

If you attempt it this way, it would never be confusing.

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