Futures, or a few words about the "future" market - Part I

The market on which negotiations for the purchase and sale of currency take place, for a specific date in the future, is called the forward market. It consists of specific types of transactions. These are settlements that we probably don't use on a daily basis, and sometimes their market is not closer to investors. Futures contracts are widely used, for example, to hedge currency risk among exporters and importers, but also constitute an interesting investment alternative. In this article we will try to provide a handful of information about them.

Transactions and futures

There are three main types of transactions on the futures market. These include: forward contracts, forward outright transactions, currency swaps and forward options, which we call otherwise. When dealing with a standard cash transaction, the time it takes to complete it is two days. More on the subject of spot billing, see this article. For forward transactions, the date of its settlement (purchase / sale) is set by the parties at a later date. When the agreed deadline is reached, there is a legal obligation to buy or sell the currency according to the concluded contract.

Standard and non-standard dates

When entering into this type of transaction, we will meet two popular concepts on the interbank market that relate to its settlement date. If we want to buy a currency or sell it on a specific date in the future, we can almost immediately receive quotes for our assets for specific dates in the future. They are so-called standard dates, i.e. multiples of the week or month, from the day the request was sent to the bank for a forward rate. Dates that are not included in standard quotes are called non-standard periods.

Standard quoted currency dates often have type designations in the tables SN (spot / next), SW (spot / 1 week), 1 M (spot / 1 month), 6 M (spot / 6 month) or 1 Y (spot / 1 year).

In the case of unregulated (broken) dates, i.e. non-standard periods of futures transactions. Once, this type of customer "wishes" in the form of a selected date, not multiples of the spot date, were calculated by the currency dealer. It is now simplified by various programs.

Forward rate and swap points

The forward rate is nothing but the rate at which our currency will be sold / bought in the future. It consists of two factors: spot rate and swap points. The latter, on the other hand, constitute the interest rate difference between the above currencies, which is expressed in the so-called swap points.

The formula for the forward course is therefore:

spot rate +/- swap points = DATE COURSE

Checkout rate, in other words the spot exchange rate is quoted by the institution with which we conclude the transaction (bank) on the spot currency date. Swap points are calculated on the basis of money market rates for a specific period.

How are swap points calculated?

To make your own, simplest swap point calculations, it's worth considering two things: 1) why is it done? and 2) what is our purpose in this?

We will illustrate it with an example. Let's assume that we are lucky owners of 1000 USD, which in a year we want to convert into PLN. However, we are afraid of exchange rate risk to our disadvantage, which may occur on USD / PLN quotations  with the upcoming elections in the United States. We believe that greater volatility on the dollar will certainly occur and we do not want to risk too much its possible weakening or strengthening (strengthening, it would be beneficial for us in this case). Fortunately, we found a person who is on the other side of the potential transaction (but with similar fears) and wants to buy dollars for PLN in a year. We set the date of the meeting to sign the exchange contract and determine its exchange rate. At this point a key question arises. What exchange rate will we make the transaction at?

Let's assume that the current USD / PLN selling rate is 3,80. The interest rate is PLN per year, in bank deposit 4% and USD 2,5%. Based on this data, it is easy to calculate the "fair" transaction rate for the year (in simplified terms we will count 360 days). Why is this a fair deal? Due to the fact that the future value of our dollars and zlotys held on these rates% bank deposits, will give us their value after a year.

PV (future value) PLN = 3,80 + (3,80 x 0,04 x 360 days / 365 days) = 3,95 (PLN FV)

PV (future value) USD = 1 + (1 x 0,025 x 360 days / 365 days) = 1,025 (FV USD)

The USD / PLN fair rate, after 360 days will be (FV PLN / FV USD) = 3,8536

Therefore, swap points are nothing more than the difference between our USD / PLN exchange rate a year before and after a year, i.e. 0,0536. In order not to do two separate actions, the above invoices can be written in one formula:

Swap points = foreign currency / PLN spot rate x (PLN% rate - foreign currency% rate) x number of days / 365 x 100

It is also worth noting that the rate we calculated does not reflect the actual stock market movements that will take place throughout the year. This is only a highly optional exchange rate, where the two parties get amounts proportional to the difference between interest rates. If the actual exchange rate of the dollar after one year were 3,70, necessarily one side, in this case willing to buy it will be lossy.