10.2 Mark to Market Value, and Parity Conditions

Question 1

The value of a foreign currency contract prior to expiration is known as what?

Answer 1

The “mark to market value”.

Question 2

What are the three steps in computing the value of a forward contract prior to expiration?

Answer 2

1. Take the difference between the current forward price and the price you locked in; 2. Multiply that by the size of the contract (in units of the “long currency”); 3. Discount for the time period remaining until the end of the contract settlement date [1 + R(days remaining / 360)].

Question 3

Provide the formula for FX mark to market and describe each component.

Answer 3

Question 4

The valuation you calculate from the FX mark to market value formula (V_t) is the value of the FX contract in terms of which: the price currency or the base currency?

Answer 4

the price currency

Question 5

Using the FX mark to market formula, the underlying contract is long the ____ currency, and the valuation is in the ____ currency.

Answer 5

base;

price;

Question 6

In the FX mark to market formula, the term “FP_t” represents the [choose: forward or spot] _______ price at time __ for a new contract maturing at time __ (long currency = ____ currency).

Answer 6

forward;

t;

T;

base;

Question 7

“FPt” is the [choose: selling or buying] ______ price, therefore you must use the ___ quote.

Answer 7

selling (aka bid) price;

bid;

Question 8

In the FX mark to market model, “FP” represents your [choose: selling or buying] price, therefore you must use the ____ quote.

Answer 8

buying;

ask;

Question 9

The difference between “FP_t” and “FP” in the FX mark to market valuation model is the _____ price of the ____ currency minus _____ price of the ____ currency, which equals what?

Answer 9

selling;

base;

buying;

base;

the unrealized, undiscounted gain or loss on your contract.

Question 10

In the FX mark to market vaulation model, “R” is the interest rate for the [choose: price or base] ____ currency interest rate, in other words the interest rate for the currency in the [choose: numerator or denominator] ________ of the exchange rate fraction.

Answer 10

price;

numerator;

Question 11

When calculating the fraction of days remaining in the year for the Econ (e.g., foreign currency, etc.) readings, use ___ in the denominator. For the readings dealing with derivatives, use ___ days in the denominator.

Answer 11

360;

365;

Question 12

Using 360 days in the denominator when calculating the percentage of days remaining in a year is the ______ convention.

Using 365 days in the denominator when calculating the percentage of days remaining in the year is the _-____ convention, aka, the _____ _____ ___ convention.

Answer 12

LIBOR;

T-bill;

effective interest rate;

Question 13

Given the following: “a 90-day forward contract long CAD 1 million against AUD at a forward rate of 1.05358 AUD/CAD”.

Which currency is the countercurrency?

Answer 13

“long CAD” refers to converting AUD to CAD. AUD is the price currency and CAD is the base currency. 1.05358 is the locked-in forward rate.

AUD is the countercurrency;

Question 14

When calculating the discounting portion of the FX mark to market valuation, assume there are 60 days remaining in a particular forward contract.

1. How does this impact the interest rate to be used?
2. Which currency’s interest rate should be used, the price currency or the base currency?

Answer 14

You must use a 60-day interest rate for the price currency.

You must use the interest rate for the price currency.

Question 15

What does the “t” in “FPt” stand for?

Answer 15

today;

Question 16

To value an FX contract using the FX mark to market model, you would look to _______ the position. You can do that by taking an _________ position in a new forward contract with the same maturity.

Answer 16

unwind;

offsetting;

Question 17

What does CIRP stand for?

Answer 17

Covered Interest Rate Parity