Currency Forwards and Options

This is driving me crazy - 2009 Q9

B part 1 & 2.

  1. Long forward demoniated in EUR contracted in CAD. Contract rate 1.63 CAD/EUR and currently it is 1.64 CAD/EUR. EUR 50m notional. Six months to expiry.

So the standard equation is spot/foreignIR - foward/DomesticIR x 50m notional. Question I have is how do you know which way round it is? Like if the Q gave your the EUR/CAD rate how would you know to flip it round? Is it as simple as denomiated currency always on the bottom?

  1. Long 100 JPY Put with a strike of 100 JPY/CAD and contract size of JPY 12.5m. Currrent rates are 102.5 JPY/CAD. Same question with this. The answer is simply 1/100 - 1/102.5 x 100 x 12.5m. But how do you know to flip it? Again notional currency always on the bottom?

  2. LONG forward demoniated in EUR contracted in CAD. Contract rate 1.63 CAD/EUR and currently it is 1.64 CAD/EUR. Six months to expiry.

  3. Short forward demoniated in EUR contracted in CAD. Contract rate 1.63 CAD/EUR and currently it is 1.64 CAD/EUR, expires today.

I have tried reading through other posts on similar topics but hasn’t seemed to help. Any help much appreciated.


Think of the foreign as a commodity.

So for example , if you are buying oil , you say USD/bbl . Why are you not confused by that ? Because it is obvious isn’t it. The denomination of oil price is USD.

So if I say EUR/CAD , CAD is the commodity and EUR is the denomination , Now if the investor is German or French it will make sense because she deals with Euros like we deal with USD.

She is buying CAD forward if she is long a EUR/CAD forward contract


so if it says US Portfolio Manager needs to deliver 1 Million CAD for - the investor is Short on the contract /CAD?

It does not matter if they gave /CAD or CAD/ would it?

yes to first q .Investor is short the (forward) CAD .

Well it would be a bit strange if they gave a CAD/Dollar quote . It is understandable if the US investor or company has a Canadian arm or bank in Canada dealing with her and is willing to only deal in CAD.

I suppose you could convert it back to USD/CAD and happily solve it . Remember she needs to be short CAD as an hedger.

I am confused with B.ii of this question. I thought that credit risk of options is only borne by the long if the option was in the money.

The option they present is currently out of the money, the strike is 100JPY/CAD while the current spot price is 102.5JPY/CAD so this put option would not be exercised (the strike is below the current spot). Since, this option is not going to be exercised, they are not due any money.

Issue was it was a JPY currency Put.

so you needed to do 1/100 - 1/102.5

since the currency quote was JPY/CAD and JPY was the currency as well.

You needed to convert it to CAD/JPY.

Sorry, currency options always seem to really confuse me.

This is a JPY put, so we want to use CAD/JPY. If it was a JPY call, would we want to use JPY/CAD? They both effectively do the same thing, correct?

Long 100 JPY Put with a strike of 100 JPY/CAD and contract size of JPY 12.5m. Currrent rates are 102.5 JPY/CAD.

Contract size = 12.5 Million JPY.

If you took the strike and spot at JPY/CAD and multiplied - you would get a weirrd JPY^2/CAD - which would not make any sense at all.

Even if it had been a Call - you need to look at the final currency on the output. Are you getting what I am saying?

CPK can you illustrate that weird calc you would get if you didn’t do the correct conversion? Thanks

look at the currency unit at the end

For 1) given this was a Put option - you would have done Max(0,100-102.5) - said put was OTM.

  1. Say it had been a call. You would have done Max(0,102.5-100) = 2.5 JPY/CAD * 12.5 Mill JPY = 31.25 JPY^2/CAD …

Hey - cheers for the help and I see where you are coming from but I guess I just need to understand two things:

Long forward demoniated in EUR contracted in CAD: This means what? We are long the CAD (our commodity)? Therefore are hedging an asset which is short CAD.Therefore only make a profit when EUR/CAD goes up as we have a right at buy it at the forward rate at expiry? Our payoff is in EUR.

Short forward demoniated in EUR contracted in CAD: This means we are short CAD? therefore again only make a profit when EUR/CAD goes down? Our Payoff is in EUR. right?

Any currency option question the rate we are looking at is 1/Currency of Notional. Correct?

Thanks CPK, makes sense. All you’re doing is converting it back into CAD because that’s your home currency.

@ mambovipi:

  • Maple Leaf is long the forward contract on EUR: they agreed to pay 1.63 CAD per 1 EUR in 6 months
  • So they want EUR to go up so that when they take their business profits in EUR, they will get more CAD when they convert back.
  • In this case, the EUR goes up slightly as the spot rate at this point in time is 1.64 CAD per 1 EUR, versus the contracted forward rate of 1.63 CAD per 1 EUR.
  • So they locked in to buy Euros at 1.63 CAD per 1 EUR
  • Now the rate is at 1.64 CAD per 1 EUR, so that’s good, their Euros convert back into more CAD
  • Reason they have a slight loss: But you also have to take into consideration the discounted domestic/foreign interest rate

Let me know if that helps or not or someone correct me if I’m wrong

Exporter - Has sold canadian equipment and will receive EUROS

they have a contract that is paying them EUROS. Their currency is CAD - they will SELL EUROS on Receipt and buy CAD.

If CAD has Depreciated - EUR has appreciated at the time of conversion - they lose out on the amount of CAD they will get.

Since their original position was SELL EUROS, BUY CAD - they will now hedge that position with BUY EUROS, Sell CAD. So their contract should be LONG Euro/CAD Forward contract.

That contact works best when EUROS - their long position appreciates (which is the condition they were trying to cover).

Importer - have bought EUR equipment, will pay EUROs.

To pay Euros - they will BUY Euros by Selling CAD.

Need to pay say 100,000 EUR = 100,000 CAD at delivery. (assuming 1 Euro = 1 CAD).

Now say Euro depreciates - becomes 0.95 EUR = 1 CAD - for the same amount of 100,000 EUR they will need 100,000/0.95 = MORE CAD.

Since their original position was BUY EUROS, Sell CAD - they will hedge that position by entering into a SHORT EURO, Long CAD Forward contract.

If the Euro depreciates - the above position will gain and offset the loss.

Is there anything wrong in what I’ve written above?

To take the first question: EXPORTER sold equipment in Europe . He will receive Euros. If the CAD depreciates and the Euro appreciates , they will GAIN ( i.e. get more CAD than expected )

But if the Euro depreciates , then they will get less CAD than expected. If their goal is to hedge against this loss then they should short the Euro forward . Then at the time of the delivery . if expectation matches actual spot , they will be protected , they will get the expected CAD ( any shortfall will be met by the short Euro fwd )

To take the next q , IMPORTER imported , will pay Euros .

He doesn’t have to worry if CAD depreciates and Euro appreciates , because he would pay less Euros than planned. If CAD appreciates , then he has to pay more EUROS . So he goes short the Euro forward and is protected when Euro depreciates. His case is same as a Canadian exporter selling in Europe

His case is mirror opposite of a European exporter who sells in Canada. If the Euro appreciates , then he will get less Euro per CAD , so he goes LONG a forward Euro i.e. a CAD/EUR contract or more naturally a short EUR/CAD fowrad contract.

Exporters are helped if their native currency depreciates . Importers are hurt when this happens .

I messed up !

This thread should go to the dogs, so much of overanalysis with only 2 days to go, just focus on the bigger picture man!

Dude - bigger picture doesn’t help in these questions, unless you understand the basics. That’s what I’ve found anyway.

Just spend most of the day going through book 5 and it’s all clear in my head.

Cheers for the help guys.