Currency Forwards And Futures Flashcards
How does currency overlay work
It manages currency risk to control losses while allowing gains to pass through to the investors benefit
Currency overlay is generally applied to the aggregate currency exposure of a diversified portfolio
How does passive hedging works
Passive currency hedging eliminates all currency risk, gains as well as losses
What is proxy hedging
This is when due to hedging cost or certain expectations about currency movement, a portfolio manager consider hedging a given currency with another currency
Describe the forward contract
A forward currency contract between two parties calls foe a delivery at a fixed future date of a specified amount of one currency agains dollars payment
The exchange rate is fixed at the time the contract is initiated
The parties of the contract are usually two banks or a bank and a non financial institution
The forward contract is not a right but an obligation for both parties of the contract
The party defaults on a contract is subject to substantial penalties
The buyer in the contract is said to take a long position, the seller a short position
What do a forward do
Allow a party to lock in the price of a currency that it needs in the future
Eliminate the uncertainty of future exchange rate fluctuations
What are the risk of the forward market
Forward exchange operation are as risky as spot transaction but the risk is carried for longer periods of time depending on the provisions of the forward contract
What are the two type of forward quotation
Outright price
The swap rate
What is the outright Price
The actual prive, such as the 180 day e($/nzd) price of 0.6724. It is used for commercial customers
What is the swap rate
The difference between forward and spot rates. It us used by professionals
Forward is a premium if forward > spot
Forward is at discount is forward rate < spot rate
Why are the forwards spread wider than spot quote
More uncertainty about distant soot rates than those in the near future
What is a future contract
A future currency contract between two parties is an exchange traded agreement calling for a delivery, at a fixed future date and place of a standard amount of one currency against a dollar payment
Foreign currency futures are similar to commodities futures
What are the 3 major trading centers
IMM the international monetary market, a division of the chicago mercantile exchange
LIFFE the London international financial futures exchange
SIMEX the singapore international monetary exchange
What the characteristics of the future contract
A specific-sized contract
A standard quotation method (American)
A trading location (exchange floor)
trading hours (24h electronic)
A standard maturity day (third Wednesday of jan, march, april, june, july, sept, octo, dec)
A specified last trading day (through the second business day prior to the wed on which they mature)
Daily marking-to-market (changes in the contract value are paid daily)
Collateral (purchaser of the contract must deposit a collateral or margin)
Settlement ( futures are usually closed with an offsetting position)
Commission ( commission from a round turn (buy/sell) no bid/ask)
Counterparties ( unknown to each other)
Properties of futures vs forward
Lower default risk
Higher liquidity
Lower transaction cost
Greater access
