Currency Futures

Home >> Treasury Topics

A currency future is the same as a forward exchange contract, except that it trades on an exchange. Each contract has a standardized size, expiry date, and settlement rules. The primary currency futures center with substantial volume is the Chicago Mercantile Exchange (CME). The CME offers futures trading between the major currencies, as well as some of the emerging market currencies; however, the volume of contracts in the emerging market currencies is quite low.

A currency futures contract is normally handled through a broker, who charges a commission. There is also a margin requirement, so that the buyer may be called upon to submit additional funds over time, if the underlying futures contract declines in value. Part of this margin is an initial deposit whose size is based on the contract size and the type of position being acquired. All futures contracts are marked to market daily, with the underlying margin accounts being credited or debited with the day’s gains or losses. If the balance of the margin account drops too far, then the contract buyer must contribute more funds to the margin account. If the buyer does not update his margin account as required, then it is possible that the position will be closed out.

Since currency futures have standard sizes and expiry dates, it is quite likely that a futures hedging strategy will not exactly match the underlying currency activity. For example, if a company needs to hedge a projected receipt of 375,000 euros, and the related futures contract only trades in units of 100,000 euros, then the company has the choice of selling either three or four contracts, totaling 300,000 and 400,000 euros, respectively. Further, if the projected currency receipt date varies from the standard futures contract expiry date, then the company will be subject to some foreign exchange risk for a few days. Thus, the standardized nature of currency futures contracts result in an imperfect hedge for users.