MBA (General)IV – Semester, International Business Unit 1
Definition of Speculation in the Forward Market
If a speculator anticipates that the US dollar is going to be FFr 5.7 in 6-months, he will take a long position in that currency.
Let us say that
the US dollar is quoted as follows:
Spot: FFr 5.6 per US$
6-months forward: FFr 5.65 per US$
If a speculator anticipates that the US dollar is going to be FFr 5.7 in 6-months, he will take a long position in that
currency. He will buy US dollars at FFr 5.65, 6 months forward. If his anticipation turns out to be true, he will sell
his US dollars at FFr 5.7 per unit and his profit
will be FFr 0.05 per US$ (=FFr
5.7 – FFr 5.65).
Now, suppose
that the speculator
anticipates a decrease
in the value of the US dollar in next 6-months.
He thinks that it will be available
for FFr 5.5 per US$. Then he will take a short position
in dollars by selling them at 6-months
forward.
If his anticipation comes true, he will
make a profit of FFr 0.15 per US$. On the other hand, if the dollar rate in 6-months actually
climbs to FFr 5.75 per US$, he will end up incurring
a loss of FFr 0.1 per US$ (=FFr 5.65 – FFr 5.75).
