Chapter 10 Flashcards
What are the 3 types of foreign currency risk
Transaction risk - risk of a short term transaction involving credit in FX with changes in FX rates before settlement
Economic risk - longer term changes in FX rate may make product/ service les able to compete against rivals
Translation risk- danger of business generating accounting losses when translating results of overseas subsidiaries
What are the 4 hedging methods for FX which do not use derivatives
Invoice currency - invoice foreigners in domestic currency
Match receipts and payments - nett off receivables and payables
Match assets and liabilities - fund foreign assets using foreign borrowing so interest payments also in foreign currency
Leading and lagging - lead (pay quicker) foreign supplier if you think foreign currency will strengthen
Lag will do the opposite
this is speculation
What must you remember for forward foreign exchange contracts
ADDIS - add a discount to the spread
What are 2 pros of FX forwards
They lock in a price, hedging downside risk
They are tailored to the investor
What are 2 cons of FX forwards
Investor loses any upside potential
Difficult to unwind the hedge, so must satisfy the contract even if customer doesn’t pay on time
What is the equation to set a forward rate using IRP
Fwd rate = spot rate * 1+interest in other / 1+ interest in base
Where base is country with 1 unit in the E.R. Eg $/£ 1.90 then £ is base
What is the standard contract size of a FX future
£62,500
What are 2 pros or FX futures
They attempt to lock in a price, hedging downside risk
Can close out position at any time
What are 4 cons of FX futures
Investor loses any upside potential
Standardized contracts (over/under) hedge
Basis risk may lead to hedge not being 100% efficient
Must post margin to the exchange
What are 2 advantages of futures over forward contracts
Transaction costs should be lower
Exact date of receipt or payment of currency does not have to be known
What are 4 disadvantages of futures compared with forward contracts
Contracts cannot be tailored to users exact requirements
Hedge inefficiencies caused by having to deal with whole number of contracts
Only a limited number of currencies available
They are more complex than forwards
What are 2 issues with using crypto for international transactions
Exchangeability - crypto likely to only be exchanged for narrow range of major currencies
Price volatility - crypto very volatile
What are 2 pros of a MM hedge
They attempt to lock in a price, hedging downside risk
Tailored to the investor
What are 3 cons of a MM hedge
Investor loses any upside potential
Difficult to unwind hedge
Unlikely to be cheaper than using forward + greater admin + greater effort involved
How do you calculate the number of contracts needed for a FX options hedge
contracts = ($ receipt \ strike price )/ standard contract size
Ensures the receipt converted to contract currency
