47 lines
4.0 KiB
Plaintext
47 lines
4.0 KiB
Plaintext
475
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SPreAD TrADINg IN CUrreNCY FUTUreS
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Of course, the market forces just described would come into play well before the forward/spot
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ratio increased to 0.82/0.80 = 1.025. The intervention of arbitrageurs will assure the six-month
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forward/spot ratio would not rise significantly above 1 + r 1/1 + r2 = 1.0099. A similar argument
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could be used to demonstrate that arbitrage intervention would keep the forward/spot ratio from
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declining significantly below 1.0099. In short, arbitrage activity will assure that the forward/spot
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ratio will be approximately defined by the above equation. This relationship is commonly referred to
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as the interest rate parity theorem.
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Since currency futures must converge with spot exchange rates at expiration, the price spread
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between a forward futures contract and a nearby expiring contract must reflect the prevailing interest
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rate ratio (between the eurodollar rate and the given eurocurrency rate).
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4 Hence, a spread between
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two forward futures contracts can be interpreted as reflecting the market’s expectation for the inter-
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est rate ratio at the time of the nearby contract expiration. Specifically, if P
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1 = price of the more
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nearby futures expiring at t1 and P2 = price of the forward futures contract expiring at time t 2, then
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P2/P1 will equal the expected interest rate ratio (expressed as 1+r1/1+r2) for term rates of duration
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t2 − t1 at time t1. It should be stressed that the forward interest rate ratio implied by spreads in futures
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will usually differ from the prevailing interest rate ratio.
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If the market expects the eurodollar rate to be greater than the foreign eurocurrency rate, forward
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futures for that currency will trade at a premium to more nearby futures—the wider the expected
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differential, the wider the spread. Conversely, if the foreign eurocurrency rate is expected to be
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greater than the eurodollar rate, forward futures will trade at a discount to nearby futures.
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The above relationships suggest that intracurrency spreads can be used to trade expectations
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regarding future interest rate differentials between different currencies. If a trader expected eurodol-
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lar rates to gain (move up more or down less) on a foreign eurocurrency rate (relative to the expected
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interest rate ratio implied by the intracurrency futures spread), this expectation could be expressed
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as a long forward/short nearby spread in that currency. Conversely, if the trader expected the foreign
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eurocurrency rate to gain on the eurodollar rate, the implied trade would be a long nearby/short
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forward intracurrency spread.
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As a technical point, a 1:1 spread ratio would fluctuate even if the implied forward interest rate
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ratio were unchanged. For example, if P
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2 = $0.81/euro and P1 = $0.80/euro, a 10-percent increase
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in both rates would result in a 810-point price gain in the forward contract and only a 800-point gain
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in the nearby contract, even though the implied forward interest rate ratio would be unchanged (since
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an equal percentage change in each month would leave F/S unchanged). In order for the spread posi-
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tion to be unaffected by equal percentage price changes in both contracts, a development that would
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not affect the implied forward interest rate ratio, the spread would have to be implemented so that the
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dollar value of the long and short positions were equal. This parity will be achieved when the contract
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ratio is equal to the inverse of the price ratio. For example, given the above case of P
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2 = $0.81 and
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4 All references to interest rate ratios in this section should be understood to mean (1 + r1)/(l + r2) where r1
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and r2 are the nonannualized rates of return for the time interim between S and F. Thus, in the above example,
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the interest rate ratio for the six-month period given annualized rates of 4.04 percent and 2.01 percent is equal
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to 1.02/1.01 = 1.0099. The reader should be careful not to misconstrue the intended definition of interest rate
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ratio with a literal interpretation, which in the above example would suggest a figure of 0.02/0.01 = 2. |