Ch.7 Question 2, 4, 7
2.) In order for a derivatives market to function most efficiently, two types of economic agents are needed: hedgers and speculators. Explain.

A speculator attempts to profit from a change in futures price. To do this, the speculator will take a long or short position in a futures contract depending upon his expectations of future price movement. A hedger, on the other hand, wants to avoid price variation by locking in a purchase price of the underlying asset through a long position in the futures contract or a sales price through a short position. In effect, the hedger passes off the risk of price variation to the speculator, who is better able, or at least more willing, to bear this risk.

4.) How can FX futures market be used for price discovery?

The futures market is useful for price discovery by obtaining the markets forecast of the spot exchange rate at different future times. FX forward prices are an unbiased predictor of future spot exchange rates, the market anticipates if a currency will appreciate or depreciate. Since the futures contracts have an expiration cycle, there are different contracts that expire at different periodic date in the future. Futures contract displays a chronological pattern from settlement prices from past CD future contracts. The pattern provides information about the relative future value of a currency against another because there are steady appreciating and depreciating pattern, although it may be mixed.

7.) List the arguments (variables) of which an FX call or put option model pricing is a function. How does the call and put premium change with respect to a change in the arguments?
There are six variables St, E, ri, r$, T and σ.

1.The larger (smaller) is St,
2.The smaller (larger) is E,
3.The smaller (larger) is ri,
4.The larger (smaller) is r$,
5.The larger (smaller) is r$