Foreign Exchange: A Practical Guide to the FX Markets

CHAPTER 7

Foreign Exchange Futures

BACKGROUND

Leo Melamed, former chairman of the Chicago Mercantile Exchange (CME), has documented, in two fascinating accounts, the beginnings and development of the market for foreign exchange futures contracts.¹ In the late 1960s, there was pressure on the fixed exchange rate system of Bretton Woods and an anticipation of the impending floating foreign exchange environment. Milton Friedman, at the invitation of the CME, published a paper in 1971 advocating a “futures market in foreign currencies”—“as broad, as deep, as resilient” as possible “in order to facilitate foreign trade and investment.”² With the additional endorsement of government, which Melamed noted was surely desirable though not legally necessary, the CME set up the International Monetary Market (IMM) as a separate entity and it was within its markets that FX futures first traded. Foreign exchange currency futures contracts emerged as a trading vehicle on May 16, 1972—the date identified as the birth of FX futures. Merton Miller, a distinguished finance professor at the University of Chicago, later praised futures contracts as “the most significant financial innovation of the last twenty years” and stated in 1986, this was, and is, singularly high praise indeed. The CME Clearing House currently processes more than 80% of all futures (not just FX futures) traded in the United States.

Just as an FX forward contract involves an agreement to buy/sell a certain amount of a certain ...