Forward Exchange Contracts Research Articles

Islamic Forward Exchange Contracts as a Hedging Mechanism: An Analysis of wacd Principle

Islamic Forward Exchange Contracts as a Hedging Mechanism: An Analysis of wacd Principle

(Net) Fair Value Accounting for Forward Contracts

This paper illustrates the contract method of accounting for a forward exchange contract under IAS 39. This differs from the method demonstrated in most current textbooks, which is based on gross accounting for the underlying rights and obligations of the forward exchange. The gross approach had been argued from the conceptual framework (eg, SAC 4) whereas IAS 39 requires the contract (net) approach. IAS 39 requires the existence of a contract for a financial instrument to be recognised and then requires accounting for that contract as a separate asset or liability from the underlying executory asset or obligations.

Hedgers, speculators and forward markets: Evidence from currency markets

Since Keynes [Keynes, J.M., 1930. A Treatise on Money, vol. II. Macmillan, London.] and Hicks [Hicks, J.R., 1939. Value and Capital. Oxford University Press, Cambridge.] propounded their theory of normal backwardation, the issue of whether hedgers must pay speculators an insurance premium has remained controversial. Recent theoretical developments incorporating the existence of market imperfections have validated the existence of an insurance premium charged to hedgers by speculators. Owing to differences in data sets and econometric methods, a consensus has not yet been reached. Drawing inspiration from asset pricing theory a model of currency returns is used, similar to that in Mark [Mark, N.C., 1988. Time-varying beta and risk premia in the pricing of forward foreign exchange contracts. Journal of Financial Economics 22, 335–354.] and the importance of speculative influences is tested. The purpose of the paper is to highlight the theoretical and statistical deficiencies of the extant literature and to examine the robustness of previous empirical results to changes in specification. Applications to risk management and forecasting are immediate, as knowledge of any insurance premium is crucial in formulating an optimal hedging strategy and an optimal forecasting model.

Measuring the degree of currency misalignment using offshore forward exchange rates: The case of the Korean Financial crisis

This paper proposes a new method of measuring the degree of currency misalignment through the use of offshore forward exchange rates. Using default risk-adjusted no-arbitrage conditions for forward exchange contracts, we calculate the spot exchange rates and the domestic interest rates that are implied from the observed forward exchange rates. The difference between the implied and the observed spot exchange rates is our measure of currency misalignment. Our methodology is based on the presumption that, during a currency crisis, offshore forward exchange rates reflect market fundamentals more closely than onshore spot and forward exchange rates. The latter are usually tightly regulated and heavily affected by government intervention during a non-normal event such as a financial crisis. We apply the method to the 1997 Korean currency crisis.

Foreign exchange and lost opportunity in the US Department of Defense

This paper examines US Department of Defense (DoD) foreign exchange rate exposure in light of the government’s prohibition against foreign currency hedging. Using data from the United States Air Force and Monte Carlo simulation, we evaluate whether the use of forward foreign exchange contracts or currency options might reduce the financial impact of currency fluctuation. The results strongly indicate that these alternatives outperform the current method for dealing with foreign currency exposure in the DoD. Using forward contracts, expected cost reductions are on the order of 3.5% of current outlays. For options, expected cost reductions increase to 6.4% thereby defining an upper bound of 2.9% on acceptable option premium levels.

Foreign currency translation information reported by Fortune 500 companies

AbstractSince the early 1980s, we have witnessed continuing expansion in U.S. foreign trade and international investment. During the same period, we also observed substantial changes in the exchange rates between U.S. dollars and other major foreign currencies. This article summarizes foreign currency translation information reported by 113 sample firms of the Fortune 500 companies in 1993. The areas covered include functional currencies, exchange gains and losses, and forward exchange contracts. The quality of corporate reporting in foreign currency translation has improved gradually since SFAS No. 52 became effective in 1982. However, many firms are still not providing disclosures that extend beyond the minimum requirements of the current standards.

Are Banks Market Timers or Market Makers? Explaining Foreign Exchange Trading Profits

We analyze the foreign exchange trading earnings of large U.S commercial banks over the past several years. In particular, we use several approaches to try to determine to what extent these profits can be attributed either to position-taking by banks or to the provision of intermediation services to bank customers. The results can be summarized as follows. First, banks appear to generate a substantial portion of their foreign exchange earnings from making markets in conventional spot and forward foreign exchange contracts. In addition, some indirect evidence supports anecdotal reports that intermediation in volatility-related products (e.g., options contracts) has been a significantly profitable activity. Finally, on average, positions in currencies do not appear to contribute to profits. Tests applied to monthly and daily data on banks' portfolio positions suggest that banks cannot accurately forecast changes in exchange rates, and that these currency positions account for only a small fraction (if any) of the banks' foreign exchange earnings.

Long-term covered interest parity and the international swap market

This paper examines the pricing of long-term forward exchange contracts. It is established empirically that the traditional covered interest arbitrage pricing relationship is often violated, and that the behaviour of long- and short-term forward exchange rates is substantively different. It is argued that activity in the international currency and interest rate swap markets provides a potential explanation for the observed “mispricing”. In particular, fixed-to-fixed currency swaps provide another form of arbitrage which can affect long-term forward exchange pricing.

Demand and supply of forward exchange contracts under incomplete information

This article derives a complete set of demand and supply functions for forward exchange contracts in a multiperiod economy under incomplete information. Investors can invest in domestic and foreign risky securities; they consume foreign as well as domestic goods that have stochastic prices. Because the aggregate exposure to exchange risk may be different from zero and because investors may have heterogeneous expectations, they take speculative positions. The central theme of the article is an analysis of the role of forward exchange contracts and the effects of incomplete information in the optimal allocation of exchange risk.

An Analysis of Intertemporal Pricing for Forward Foreign Exchange Contracts

ABSTRACTAn asset‐pricing model with an unobservable time‐varying risk premium is used to price forward foreign exchange contracts. Specifically, the term spectrum of forward foreign exchange contracts is examined in order to focus on country‐specific and maturity‐specific information. The testable restrictions imposed by the model are consistent with both cross‐country and cross‐maturity forward contracts except at the short end of the maturity spectrum for cross‐country forward exchange rates. This indicates that the intertemporal model is relatively robust in valuing forward contracts of different maturities and for different exchange rates but that it may fail when there are significant short‐term country‐specific shocks.

Time-varying betas and risk premia in the pricing of forward foreign exchange contracts

This paper specifies the single-beta capital asset pricing model for the pricing of forward foreign exchange contracts from the point of view of a U.S. investor. Parametric specification of the betas as ARCH-like processes explicitly allows for time variation as well as sign variation of the risk premium in the forward foreign exchange market. I estimate the model jointly for four currencies, using a generalized method of moments procedure. The results show significant time variation for the betas and tests of the overidentifying restrictions are generally favorable to the model.

Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection

ABSTRACTIn this paper, ex ante efficient portfolio selection strategies are developed to realize potential gains from international diversification under flexible exchange rates. It is shown that exchange rate uncertainty is a largely nondiversifiable factor adversely affecting the performance of international portfolios. Therefore, it is essential to effectively control exchange rate volatility. For that purpose, two methods of exchange risk reduction are simultaneously employed: multicurrency diversification and hedging via forward exchange contracts. The empirical findings show that international portfolio selection strategies designed to control both estimation and exchange risks almost consistently outperform the U.S. domestic portfolio in out‐of‐sample periods.

Tests of expected real profits in the forward foreign exchange market

This paper tests the hypothesis that the expected real profits in the forward exchange contract are zero, as implied by Frenkel and Razin's (1980) stochastic prices model and the assumption of risk neutrality.

Currency Risk and Relative Price Risk

This paper demonstrates the strong linkages that exist between currency risk, represented by inflation risk and exchange rate changes, and relative price risk. These linkages affect the optional quantities of forward exchange contracts, nominal debt, and fixed price sales (purchase) contracts to use in hedging against these risks. It is shown that the existence of as many hedging mechanisms as there are forms of price risk allows for the precise targeting of specific price risks with specific hedging instruments. Moreover, even though each hedging mechanism specializes in protecting against a particular form of price risk, the optimal quantitiy of each influences and is influenced by the optimal quantities of the others.

Designing spreads in forward exchange contracts and foreign exchange futures

Journal of Futures MarketsVolume 3, Issue 4 p. 355-368 Article Designing spreads in forward exchange contracts and foreign exchange futures Michael Adler, Michael Adler Michael Adler is Professor of Finance at the Graduate School of Business, Columbia University.Search for more papers by this author Michael Adler, Michael Adler Michael Adler is Professor of Finance at the Graduate School of Business, Columbia University.Search for more papers by this author First published: Winter 1983 https://doi.org/10.1002/fut.3990030403Citations: 5 AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinked InRedditWechat Citing Literature Volume3, Issue4Winter 1983Pages 355-368 RelatedInformation

The Forward Exchanges-(Continued)

H ' tAVING described the operations of the bank dealer in buying, selling, and covering his transactions on the forward exchange market, we turn to an analysis of certain typical transactions in forward exchange. 2. Types of transactions in which forward contracts are used.The type of transaction generally cited by the textbooks as giving rise to a forward exchange contract is the purchase by an importer, or sale by an exporter, of goods in terms of a foreign currency. An importer who has contracted, or is about to contract, for goods in some foreign currency, wishing to insure himself against fluctuations in the exchange rate, buys the currency which he will need to meet his obligation one, two, or three months hence in the form of forward exchange. By doing so he knows immediately what his cost will be in terms of his own currency. If he waited, he might have to pay considerably more for his goods than the spot exchange rate existing at the time of making his decision would have indicated. Of course, he might have to pay considerably less, in terms of sterling (which I will use throughout as the domestic currency) if the rate rose. But the merchant is ordinarily not an exchange speculator, and he desires every bit of certainty he can get in his business. The existence of a forward market enables him to quote his buying prices in terms of foreign currencies and at the same time know what they will be in terms of his own. Similarly, the exporter who makes, or is about to make, a sale to a foreign buyer in terms of the buyer's currency is enabled to sell the currency forward, and thus insure his sterling price against a rise in the rate. To the merchant making this sort of a transaction, the amount of the discount, if he is a seller, or of the premium, if he is a buyer, on forward, as compared to spot, is considered as an insurance cost. If the forward rate is at a premi-