Essentials

Question 1

Forward contract

Answer 1

Customized contract between two parties to buy or sell an asset at a specified price on a future date.

Question 2

Future contract

Answer 2

Futures are (standardized) derivative financial contracts that obligate (!) the parties to transact an asset at a predetermined future date and price.

Question 3

Direct quotation

Answer 3

HC/FC: units of domestic currency per unit of foreign currency. Base currency= FC/Pricing currency= HC

Question 4

Indirect quotation

Answer 4

FC/HC

Question 5

Exchange rate name vs dimension (direct quotation)

Answer 5

FC/HC: value of the first currency expressed in the second currency –> S= HC/FC (direct quotation): units of HC per unit of FC

Question 6

Bid rate

Answer 6

Rate at which the bank buys from you (bidding you money) - you sell!

Question 7

Ask rate

Answer 7

Rate at which bank sells to you (asking you for money) - you buy!

Question 8

Spread rate

Answer 8

Difference between ask and bid (ask > bid)

Question 9

Primary rates

Answer 9

Exchange rates against the USD

Question 10

Cross rates

Answer 10

Rates not involving the USD

Question 11

Synthetic contract

Answer 11

Combination of two or more transactions that yields the same outcome as the originial contract (e.g. synthetic cross rate)

Question 12

Exchange rate (S)

Answer 12

Price of one currency (base) in terms of another (pricing)

Question 13

Swap rate

Answer 13

Difference between forward and spot rate (F-S)

Question 14

Forward discount

Answer 14

Forward rates are below the spot rate at all maturities (discount for FC)

Question 15

Forward premium

Answer 15

Forward rates are above the spot rate at all maturities (premium for fc)

Question 16

CIP (covered interest rate parity)

Answer 16

Relationship between interest rates and spot and forward currency values of two countries are in equilibrium: (1+i)=(S/F)​∗(1+i*​)

• -> no opportunity for arbitrage using forward contracts
• -> CIP and UIP are the same when forward and expected spot rates are the same

Question 17

UIP (uncovered interest rate parity)

Answer 17

The difference in interest rates between two countries will equal the relative change in currency foreign exchange rates over the same period: F0​=S0∗(​1+i1)/
(1+i2)​​ –> higher interest rate at home predicts a depriciation of HC

Question 18

Difference UIP and CIP

Answer 18

CIP involves using forward or futures contracts to cover exchange rates (hedging). UIP involves forecasting rates and not covering exposure to foreign exchange risk (no forward rate contracts, since it uses only the expected spot rate)
–> no theoretical difference between CIP and UIP when the forward and expected spot rates are the same

Question 19

Meese-Rogoff-Result

Answer 19

Random walk is the best forecast model for exchange rates –> current exchange rate is “optimal predictor” of future spot rate and summarizes market expectations

Question 20

Disconnect puzzle

Answer 20

Past and current macro fundamentals don’t explain/forecast exchange rates

Question 21

Engel and West

Answer 21

Exchange rates as assets: Driven by current and expected future fundamentals. –> Thus, predictability does not mean that exchange rates are disconnected from fundamentals.

Question 22

Call

Answer 22

Right (option) to buy a stock

Question 23

Put

Answer 23

Right (option) to sell a stock

Question 24

Long

Answer 24

Buying (e.g.option/forward). Betting on rising prices

Question 25

Short

Answer 25

Selling (e.g. option/forward). Betting on falling prices

Question 26

Long call

Answer 26

Buying the right (option) from someone to buy a stock for a given price

Question 27

Long put

Answer 27

Buying the right (option) from someone to sell a stock for a given price

Question 28

Short call

Answer 28

Selling the right (option) to someone to buy a stock from you for a given price (thus you are selling)

Question 29

Short put

Answer 29

Selling the right (option) to someone to sell a stock to you for a given price (thus you are buying)

Question 30

Strike price

Answer 30

Price at which a derivate contract can be bought

Question 31

A/R

Answer 31

Accounts Receivable: money which is owed to a company –> right to receive those accounts because of former delivery of product/service

Question 32

A/P

Answer 32

Accounts Payable: debts that a company must pay off –> e.g. short-term debt to suppliers

Question 33

ATM

Answer 33

At the money: strike price is identical to the price of the underlying security

Question 34

OTM

Answer 34

On the money: strike price is higher (lower) than the market price of the underlying asset for a call option (put option) –> no intrinsic value (worthless at expiry)

Question 35

ITM

Answer 35

In the money: strike price is favorable in comparison to the market price of the underlying asset (call: buying below current price; put: selling above current price)