Question

Suppose you're a speculator with a base currency of USD. Your view is that JPY interest rates will go down more than the market expects. Instead of buying a physical JPY bond to implement your view, you decide to purchase a JPY bond future.

Question: When you put on the trade, do you have exposure to Yen? If not, why not? If so, why, and what do you do about hedging it. (Ignore issues of posting initial margin.)

Answer 1

If the speculator expects Japanese interest rates to go down more than market expectations, then Yen denominated bonds should increase in price. However, in a speculative trade one does not take exposure in the physical asset and instead opens a position in the futures market. Hence, the speculator would have a position in the derivatives (Yen Bond Futures) market without any corresponding position in the physical asset market. The same is done by means of posting initial futures margin. The position can be hedged by shorting a forward contract on the bond futures so as to sell the bond futures at a particular pre-determined price.