Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

FM > 10. FM - Managing risk: overseas trade > Flashcards

10. FM - Managing risk: overseas trade Flashcards

1
Q

Describe forward rates at a discount

A

More $ per £
So add
Currency is depreciated

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Describe premium forward rates

A

Less $s per £
So subtract
So appreciates

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is the alternative to hedging currency exposure with a forward contract?

A

A company can use the money markets to lend or borrow, and achieve a similar result

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

How do you hedge a payment on a money market hedge

A
  • Buy the PV of foreign currency amount today at the sport rate
    ( Like the firm making an immediate and certain payment in sterling)
    May involve borrowing the funds to pay earlier than the settlement date
  • Foreign currency purchased is placed on deposit and accrues interest until the transaction date
  • Deposit is then used to make the foreign currency payment
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

How do you hedge a receipt?

A
  • If you are hedging a receipt, borrow the PV of the foreign currency amount today
    Sell it at the spot rate
    Results in an immediate and certain receipt in sterling
    This can be inv until the date it was due
  • Foreign loan accuses interest until the transaction date
  • Loan is then repaid with the foreign currency receipt
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Describe a future

A

A standardised version of a forward
They are like forwards in that
- The company’s position is fixed but eh rate of exchange in the futures contract
- It is a binding control

However

  • Futures are for standardised amounts
  • Futures can eb traded on currency exchanges

because each contract is a standard amount and with a fixed maturity date, they may not cover the exact foreign currency exposure

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

How is foreign currency exposure dealt with with futures?

A

because each contract is a standard amount and with a fixed maturity date, they may not cover the exact foreign currency exposure

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

How do you determine whether to buy or sell futures?

A

Depends on whether the contract is dominated in sterling or in a foreign currency
The examine will give you contracts dominated in sterling, so the decision depends on what you will be doing with the sterling

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

How does a sterling futures contract work?

A

i.e. a contract size given in £
If a company is going to be buying currency in the future, then it will be selling sterling
Therefore it needs to SELL sterling contracts

If a company is going to be selling currency in the future, then it will be buying sterling. So needs to BUY sterling contracts

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What happens if a sterling futures contract is for buying currency in the future?

A

If a company is going to be buying currency in the future, then it will be selling sterling
Therefore it needs to SELL sterling contracts

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What happens if a sterling futures contract is for selling currency in the future?

A

If a company is going to be selling currency in the future, then it will be buying sterling. So needs to BUY sterling contracts

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What is a transaction risk?

A

The risk tat an exchange rate will change between the transaction date and the subsequent settlement date i.e. it is the gain or loss arising on conversion

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What does transaction risk primarily arise on?

A

On imports and exports

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Give an example of how transaction risks occur on import and exports

A

A firm enters into a contract on 1 Jan to buy a piece of equip from US for $300k
Invoice is to be settled on 31 March
The exchange rate on 1st Jan is $1.6/£ therefore the firm expects the cost to be £187.5k
However, by 31st March, the £ may have
-> Strengthened to $1.75/£ in which case the cost will have fallen to £171,429 OR
-> depreciated to $1.45/£ in which case the cost has risen in £206,897

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is an economic risk

A

Is the variation in the value of the business (i.e. the PV of future cash flows) due to unexpected changes in exchange rates
It is a LT version of transaction risk

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

When can economic risk occurs for an export company

A
  • Home currency strengthens against the currency in which is trades
  • A competitor’s home currency weakens against the currency in which it trades
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What is the solution for economic risk?

A
  • A favoured, but LT solution is to diversify all aspects of the business internationally
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What is a translation risk?

A

Where the reported performance of an overseas subsidiary in home based currency terms is distorted in consolidation financial statements because of a change in exchange rates

This is an accounting risk rather than cash based one

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Is a translation risk an accounting risk or cash based risk?

A

Accounting risk

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

How are quoted exchange rates quoted?

A

Banking dealing in foreign currency quote 2 prices (a spread) for an exchange rate

  • A lower ‘offer’ price
  • A higher ‘bid’ price
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

What are the rates being offered if a dealer is quoting a price for US$/£ of 1.4325 - 1.4330

A

The lower rate, 1.4325, is the rate at which the dealer will SELL the variable currency (US dollar) in exch for the base currency (sterling)
The higher rate 1.4330, is the rate at which the dealer will buy the variable currency (US dollars) in exchange for the base currency (sterling)

The bank will always trade at the rate that is more favourable to itself

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

How do you know which exchange rate a banker will chose?

A

The bank will always trade at the rate that is more favourable to itself

23
Q

TYu2: The US Dollar/ Sterling rate is quoted as 1.4325 - 1.4330
Comp A wants to buy $100k in exchange for sterling

What rate will the bank offer?

A

Comp A wants to buy $100k in exchange for sterling (so that the bank will be selling dollars)
- at the lower rate of 1.4235 the bank would sell $100k for £69,808
at the higher rate of 1.4330, the bank would sell $100k for £69,784
Clearly the bank would be better off selling at low rate

RULE = Banks sells low
Banks BUY high

24
Q

What are the potential solutions for dealing with transaction risk?

A

Invoice in home currency
Leading and lagging
Matching
Foreign currency bank accounts

25
Q

How does invoicing in the home currency protect against transaction risk?

A
  • Insist all customers pay in your own home currency and pay for all imports in home currency
  • This method transfers risk to other party
  • But may not be commercial acceptable
26
Q

How does lagging protect against transaction risk?

A
  • If an importer expects that the currency it is due to pay will depreciate, it may attempt to delay the payment (lagging)
  • This may be achieved by agreement or by exceeding credit terms

Note: strictly this is not hedging, it is speculation

27
Q

How does leading protect against transaction risk?

A
  • If another exporter expects that the currency it is due to receive will depreciate over the next few months, it may try and obtain payment immediately (i.e. leading)
  • May be achieved by offering discount for immediate payment

Note: strictly this is not hedging, it is speculation

28
Q

What is the difference between hedging and speculating?

A

Hedging: protecting yourself against adverse changes
Speculating: Betting on the exchange rate changing in your favour

29
Q

How does matching protect against transaction risk?

A
  • When a company has receipts and payments in the same foreign currency due at the same time it can simply match them off against each other
  • If is then only necessary to deal on the forex markets for the unmatched portion of the total transactions
30
Q

How does having foreign currency bank accounts protect against transaction risk?

A
  • Where a firm has regular receipts and payments in the same currency, it may choose to operate a foreign currency bank account
  • This operates as a permanent matching process
  • The exposure to exchange risk is limited to the net balance on the account
31
Q

What is the method for hedging with forwards

A

If we know that we are going to pay or receive currency in the future, we will agree to translate this currency at a rate agreed now (forward rate)

A forward contract is an obligation to accept or deliver a certain amount of a foreign currency on a certain date in the future

32
Q

What is the number of contracts required for a sterling contract?

A

As usual, this will be transaction amount / contract size
However, when using sterling contracts, the contract side will be in £ but the transaction amount will be in currency
Therefore you need to convert the transaction amount into £ first (using the futures price)

33
Q

When do sterling contracts need to be translated?

A
  • if using sterling contracts, the futures prices will be given as currency per £ (e.g. $/£)
    So prof/loss on the future will need to be translated at the spot rate on the transaction date

This will also be the case with the premium on an option as the premium is paid upfront, so it must be translated at the current spot rate

34
Q

Define an option

A

Gives the right but not the obligation to buy or sell currency at some point in the future at a predetermined rat

35
Q

What are the 2 options for an option, and when would you let them happen?

A
  • Exercise option if favourable

- Let is lapse if the spot rate is more favourable, or there is no longer a need to exchange currency

36
Q

What is the benefit of an option?

A

It eliminates downside risk
BUT allows participation in the upside

But this additional flexibility comes at a price

37
Q

Why are options more expensive?

A

It eliminates downside risk
BUT allows participation in the upside

But this additional flexibility comes at a price

38
Q

Can currency options be traded?

A

Yes, can either have tailor made OTC options or use traded currency options

39
Q

How are OTC currency options dominated?

A

In foreign currency

40
Q

How do you decide whether you need a currency put or call option?

A

You need to consider what you will be doing with the foreign currency (as it is generally denominated in foreign currency)

  • If the company is going to be BUYING currency in the future, then it will need to buy a CALL option
  • If the company is going to be SELLING currency in the future, then it will need to buy a PUT option
41
Q

When do you need to buy a CALL option for currency options?

A

You need to consider what you will be doing with the foreign currency (as it is generally denominated in foreign currency)

  • If the company is going to be BUYING currency in the future, then it will need to buy a CALL option
42
Q

When do you need to buy a PUT option for currency options?

A

You need to consider what you will be doing with the foreign currency (as it is generally denominated in foreign currency)

  • If the company is going to be SELLING currency in the future, then it will need to buy a PUT option
43
Q

When do you need to buy traded option PUTS?

A

As for futures, the examiner will give you contracts denominated in STERLING, therefore if a company is going to be buying currency in the future, then it will be SELLING sterling
It therefore, needs to by PUTS

44
Q

When do you need to buy traded option CALLS?

A

If the company is going to be selling currency in the future, then it will be BUYING sterling
Therefore it needs to buy CALLS

45
Q

What does IRPT stand for?

A

Interest Rate Parity theory

46
Q

What does Interest Rate Parity Theory claim?

A

Claims that the difference between the spot and the future exchange rates is equal to the differential between interest rates available in the 2 currencies

47
Q

What is the IRPT used for?

A

Used by banks to calculate the forward rate quoted on a currency
The formula is
Forward rate = Current spot rate x [(1 + if) / (1 + iuk)]

Where
if = foreign currency interest rate for the period
iuk = UK interest rate for the period

48
Q

Does IRP hold true in practice?

A

Yes
There are no bargain interest rates to be had on loans/ deposits in one currency rather than another

However, where a gvmt imposes controls on currency trading, or otherwise intervenes in the currency markets, its effectiveness is limited

49
Q

What does PPP stand for?

A

Purchase power parity

50
Q

What does PPP claim?

A

Claims that the rate of exchange between 2 currencies depend on the relative inflation rates within the respective countries

51
Q

What is PPP based on?

A

The Law of One Price

i.e. in equilibrium, identical goods must cost the same regardless of the currency in which they are sold

52
Q

What is the impact of inflation on depreciation of currency

A

The higher the inflation, the greater the depreciation of the currency

53
Q

How do you estimate expected future sport rates?

A

Apply the following formula

Forward rate = Current spot rate x [ (1+ inflf) / (1 + influk)

Where
inflf = expected foreign currency inflation rate for the period
influk = expected UK inflation rate for the period

54
Q

Give some examples of risks that international trade increases

A
  • Physical risk
  • Trade risk
  • Liquidity risk
  • Credit risk

FM (12 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions