CURRENCY FUTURES

INTRODUCTION
A currency future, also FX future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. Typically, one of the currencies is the US dollar. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange markets.

History

Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972, less than one year after the system of fixed exchange rates was abandoned along with the gold standard. Some commodity traders at the CME did not have access to the inter-bank exchange markets in the early 1970s, when they believed that significant changes were about to take place in the currency market. They established the International Monetary Market (IMM) and launched trading in seven currency futures on May 16,1972.
Pricing
The pricing of a currency futures contract is completely determined by the prevailing spot rate and interest rates. Otherwise, investors would be able to arbitrage the difference between the futures and spot prices.
The futures price is given by:
where:
F = futures price
S = spot price
rT = interest rate of the term currency
rB = interest rate of the base currency
T = tenor (calculated according to the appropriate day count convention)
Uses

Hedging
Investors use these futures contracts to hedge against foreign exchange risk. If an investor will receive a cash flow denominated in a foreign currency on some future date, that investor can lock in the current exchange rate by entering into an offsetting currency futures position that expires on the date of the cash flow.

BY VIVEK MITTAL