Chapter 10Vanilla FX Derivatives Miscellaneous Topics

Several FX derivatives pricing technicalities have thus far been brushed under the carpet. In this chapter, present and future valuing, tenor expiry date calculations, and premium conversions are examined.

Present Valuing and Future Valuing

It is well understood that $10 received today is worth more than $10 received in the future due to the time value of money. The core of the argument is that money received now has interest-earning potential if it is placed on deposit (of course, assuming interest rates are positive).

  • Present valuing involves bringing a cash value in the future back to its equivalent value at the present day. In derivatives, option values are often calculated at maturity and must then be present valued.
  • Future valuing is the opposite operation: taking a cash value today and pushing it to some future date.

The calculation for present and future valuing uses a discount factors c10-math-0001 to a given maturity in the currency in which the cash value in denominated. Discount factors are generally less than 1 and:

equation

Discount factors are calculated from interest rates but the exact calculation depends on how interest compounds on the deposited cash balance. If interest is all paid in one payment at the deposit maturity, the ...

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