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F3 Revision > Chapter 9 > Flashcards

Chapter 9 Flashcards

1
Q

Definition of exchange rate

A

Expressed in terms of the quanity of one currency that can be exchanged for one unit of the other currency

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2
Q

Direct quotes

A

One unit of foreign currency = its value in home currency

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3
Q

Indirect quotes

A

One unit of home currency = its value in foreign currency

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4
Q

What is the spot rate?

A

Rate given for a transaction with immediate delivery

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5
Q

Reasons for forecasting exchange rates

A

Foreign debtor and creditor balances
Working capital
Pricing
Investment appraisal
Consolidation of foreign subsidiaries

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6
Q

Two theories to help predict foreign exchange rate movements

A

Purchasing power parity
Interest rate parity

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7
Q

Purchasing price parity

A

Law of one price
Country with higher inflation will suffer a fall in the value of its home currency
Assumes rates are quoted as indirect quotes

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8
Q

Limitations of purchasing power parity

A

Future inflation rates may not be accurate
Speculation
Government intervention

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9
Q

Interest rate parity

A

Difference between spot and forward rate is equal to differential between interest rates available in two currencies
Both countries have the same real interest rate
Country with higher inflation rate will suffer a fall in the value of its currency
Assumes rates are quoted as indirect quotes

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10
Q

Limitations of interest rate parity

A

Controls on capital markets
Controls on currency trading
Government intervention

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11
Q

Internal methods of currency risk management

A

Home currency
Leading/Lagging
Matching/Netting
Countertrade

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12
Q

Home currency

A

Passes risk to other pary
Unlikely to be commercially acceptable

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13
Q

Leading/Lagging

A

Speed up/delay payment depending on expectations of exchange rate movement

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14
Q

Matching/Netting

A

Match/net off transactions in the same currency
Easier if use foreign bank accounts

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15
Q

Countertrade

A

Avoid using currency and exchange products of equivalent value

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16
Q

Definition of forward contract

A

Binding agreement to buy or sell a specific amount of foreign currency at a given future date using an agreed forward rate

17
Q

Advantages of forward contracts

A

Simple
Low transaction costs
Fix the exchange rate
Tailored

18
Q

Disadvantages of forward contracts

A

Contractual commitments
Lose upside potential
Forward markets banned in some countries

19
Q

Basic ideas of money market hedges

A

Avoid future exchange rate by making exchange now
Use interest rates to create assets and liabilities that ‘mirror’ the future assets and liabilities

20
Q

Advantages of money market hedges

A

No currency risk
Fairly low transaction costs
Offers flexibility
May be able to use when forward contracts not available

21
Q

Disadvantages of money market hedges

A

Complex
May be difficult to get overseas loan
A company with a large overdraft may struggle to borrow funds now

22
Q

Reasons why hedge may not be perfectly efficient

A

Rounding the number of contracts
Closing out before expiry date

23
Q

Advantages of currency futures

A

Effectively ‘fix’ the exchange rate
No transaction costs
Tradable

24
Q

Disadvantages of currency futures

A

Require up front margin payments
Not for precise tailored amounts

25
Q

Definition of currency options

A

Right, but not an obligation, to buy or sell a currency at exercise price on a future date

26
Q

Features and operation of currency options

A

If favourable movements in rates the company will allow the option to lapse. The right will only be exercised to protect against an adverse movement
Writer of option will charge a non-refundable premium

27
Q

Two types of options

A

Call option gives holder right to buy the underlying currency
Put option gives holder the right to sell the underlying option

28
Q

Advantages of currency options

A

Can benefit it rates move favourably
Many choices of strike prices, dates and premiums
Can be allowed to lapse if not required

29
Q

Disadvantages of currency options

A

High up-front premium costs
Traded options are not for precise tailored amounts

30
Q

Intrinsic value

A

Difference between exercise price of the option and current market value of the product
Option with this is knows as ‘in the money’

31
Q

Time value

A

Difference betweent the actual premium and the intrinsic value

32
Q

Out of money meaning

A

Strike price is less favourable than the current spot rate

33
Q
A

F3 Revision (15 decks)

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